Stagflation Likely, But ‘Short Lived’ As Inflation Heats Up

As inflation picks up and interest rates continue to rise, the single family home market “looks most vulnerable” to a more serious correction, according to CBRE’s global chief economist Richard Barkhambut he and other experts agree that the economy appears positioned to continue to support CRE fundamentals in the near term.

In a recent discussion with the firm’s Spencer Levy, Barkham said the Fed funds rate will likely peak in 2023 at 2.5%, and growth will slump from around 3% this year to 2% next year. But the possible residential correction “isn’t a foregone conclusion,” he said, especially if unemployment remains low.

“We do believe that this term stagflation will take over from pandemic as the biggest concern, but it will be short lived,” he told Levy. “This is not the 1970s, and we believe that the economy will continue to provide reasonable support for commercial real estate fundamentals over the next 12 and 18 months. We may well see some yield correction, my colleagues will discuss that, but certainly no riot in the real estate sector.”

On the commercial real estate side, this will have different impacts to different asset classes.  Levy opines that “perhaps the most hard-hit” asset class in the near term is value-add office, where CBRE has already observed fewer bidders at play. 

“Many of our developer clients have already increased their underwriting to add 200 basis points to their expected cost of debt over the next several years,” he said.

Levy also notes that alternative lenders have taken the top spot in the debt capital markets, and many investors are seeking multifamily, bridge, and construction financing.

“From an underwriting perspective, we’re getting a couple of basic questions,” Levy said. “One is, how do I underwrite my exit cap rates in an inflationary environment? And our answer is very straightforward. If you’re planning on holding your asset for three years or longer, don’t raise your exit cap rate, more than you normally would.” 

CBRE is taking the position that after two years from now, inflation will be “tame”and Levy said that could be the case even in a year from now. His approach? One of enthusiasm tempered by the likelihood of “choppiness” in the market until the inflationary environment is more certain.

“Don’t change those exit cap rate assumptions because we think that the short end of the curve, while it may peak in around that two and a half percent level…we think it’s going to rapidly fall back to about that one and a half percent level in 2024,” Levy said.

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