U.S. Macro Outlook: Mild Recession ≠ Pleasant



INDUSTRIAL Fundamentals Set to Rebalance

excess space they had leased. Since the onset of the pandemic three years ago businesses have been aggressively rationalizing their office footprints (a continuation of the multi-decade trend of corporates pushing for efficiency). Occupiers can only cut so much space before it becomes disruptive to their business. The first quarter will be very telling but for now our outlook calls for the steepening in negative absorption that we observed in H2 2022 will continue as the labor market softens and ultimately sheds jobs. This, in combination with the continued remote working downdraft (office space per worker continuing a steady downtrend as leases expire) and greater economic uncertainty will result in -66 msf of absorption in calendar year 2023, worse than the -37 msf observed in 2022. On the supply side, 90.4 msf were under construction at the end of 2022. We estimate that 35-40 msf of that new product will be delivered in 2023 and another 25 msf will come online in 2024. With new supply once again exceeding demand, the U.S. office vacancy will rise from 18.2% in 2022 to 20.2% by the first half of 2024, and effective rents will continue to move downward by another 7% in 2023. The total peak-to-trough rent decline is likely to be around 20% by mid-2024. As the economy pulls out of recession toward the end of this year, office demand will begin to stabilize and turn positive in 2024. Office vacancy will begin to gradually trend lower as office-using job growth accelerates to the point where net absorption exceeds new construction levels. In general, our research conclusively shows that demand for office space is distinctly trifurcated. The Top : Buildings that have been newly constructed or renovated in the last eight years that offer trophy building experiences have registered over 100 msf positive absorption since 2020. Vacancy in this segment is much lower than the national average, and we expect this segment to remain tight over the forecast horizon. The Middle : A large slice of office product (roughly 60% of stock) classifies within a middle ground of commodity or similar office product and in general will require reinvestments and upgrades to remain competitive. The Bottom : Meanwhile, up to 20% of office stock throughout the country is becoming increasingly undesirable and will need to be reimagined and made relevant for the future.

The industrial economy has been whipsawed over the last few years: Manufacturers that were initially shut down in the early days of the pandemic ramped up just as consumers—flush with cash from stimulus and cooped up at home—doubled down on online goods spending. This resulted in supply chains becoming snarled, with elevated backlogs of orders and a multi-year bifurcation in the recoveries between e-commerce adjacent sectors and the rest of industrial—namely, manufacturing, wholesale and transportation (excluding final mile). Employment in the industrial labor market is now 1.3 million jobs above pre-pandemic levels, with 65% of those, or 866,000, accruing to warehousing/final mile, which only represented 9% of the industrial sector’s employment in early 2020. The pandemic boom in consumer goods spending pushed demand for industrial CRE through the roof. Absorption had averaged 287 msf from 2015 to 2019, but fast forward to lockdowns and consumers unable to spend on services, and absorption surged to 561 msf in 2021—the highest ever recorded— followed by 477 msf in 2022. Some of this demand was an accelerated response to a level shift in online shopping—meaning that this demand was pulled forward from future years as companies had to scale sooner and quicker than expected. As 2022 unfolded, a few important trends started to emerge that will define the undercurrents of the outlook in 2023. First, goods spending started to taper back toward pre-pandemic trend levels as stimulus and excess savings were spent, either increasingly on services like travel and entertainment, or on absorbing high inflation. Second, e-commerce growth reverted to its pre-pandemic trend i.e., online sales are still capturing a greater share of total retail sales relative to pre-pandemic levels but the rate of growth has slowed). Third, higher interest rates began to weigh on demand for items sensitive to financing conditions, especially durable goods. U.S. manufacturers started to see demand wane and pulled back on production, with the exceptions of the energy and auto subsectors. Wholesalers and retailers—some bloated with inventories relative to pre-pandemic trends—registered disappointing sales in the second half of the year, further augmenting concerns about overhang. This, combined with a major snapback in housing activity, has led to significant declines in imports. Real imports are off 3.7% from their recent peak levels, but consumer goods have fallen by 15.4%, and durable goods have cratered by 25.9%. Heading through 2023, these headwinds will remain and blow harder as consumers face tighter financial conditions, fewer and less rosy job prospects, and still-high inflation. It is no wonder that producer prices and consumer


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