What The Latest Inflation Numbers Mean For CRE

After soaring throughout the first half of 2022, inflation is beginning to flatten, prompting speculation as to how the Fed will react at their September meeting. Headline inflation came in at 8.5%, down from last month’s 9.1%, while core inflation numbers, which omits the oil, gas, and food sectors, held steady at 5.9% on a downswing from 6.4% in March.  

And “that’s good news,” says Marcus & Millichap’s John Chang. “Basically, things aren’t getting worse.”

Chang says he expects inflation to slowly come down over the next several months but doesn’t think the improvements are tied to the Federal Reserve’s rate hikes. He notes that supply chains are finally beginning to even out and the average length of time to ship goods from China is declining.

“The Fed’s trying to force the market back into alignment by reducing demand and they’re doing that by raising borrowing costs,” he says. “It’s basically the only tool they have.”

But because household savings and balance sheets are so strong, Americans aren’t borrowing as much to cover higher costs – so raising rates doesn’t have as much as an impact. Retail sales are still climbing, though home sales have slumped.

The most recent inflation numbers were “pretty much what I hoped would come out,” Chang says, and he predicts the Fed will again raise rates in September, likely by 50 basis points. The Fed is also scheduled to double their quantitative tightening program in September, raising their monthly balance sheet reduction to $95 billion per month. That will put upward pressure on the 10-year Treasury.

“That’s the not-so-good news for investors.  Inflation will likely remain stubbornly high, and interest rates will likely continue to climb,” Chang says.  But elevated inflation will likely also have minimal impact on space demand for commercial real estate: while apartment vacancy ticked up a tad in the third quarter, Chang says the increase is a “normalization of the market” post-COVID.  And demand for retail, industrial, and hotels should remain relatively strong. Office space demand will be stable, but at a high vacancy rate of around 16% nationally.

“The more important aspect will be how rising interest rates affect commercial real estate investor activity through the remainder of this year and into 2023. The market has already begun to recalibrate,” he says. “Some sellers are reducing prices to meet the market, while some buyers are reducing their leverage to meet their yield hurdles. Overall, the CRE market remains liquid with strong investor activity.”

Source link