Good news and bad news for the commercial real estate industry
By Christopher Thornberg
The ugly presidential election and surge in COVID-19 cases during the last quarter of 2020 topped off a dreadful year for the U.S. economy. But despite the stream of negative headlines, the nation’s economy has proven far more resilient than most forecasters predicted.
The U.S. economy is poised for strong growth in 2021 as COVID-19 vaccines are rolled out. This growth will occur irregardless of Congress passing another stimulus plan, given that the first stimulus has yet to truly kick in. Most of the first stimulus plan involved fire-hosing money across the U.S. economy through the PPP loans and direct payments to individuals. Most of this cash ended up with households who were not suffering any major economic hardship, outside of not being able to consume at the desired level. As such, most of the stimulus money passed directly through into the banking system. Data from the U.S. Bureau of Economic Analysis suggests the nation’s households have already amassed $2.5 trillion in savings since the start of the pandemic, well over double the amount saved in 2019. This liquidity will spur a consumption boom next year, and also helps to explain the hot housing market and the lofty heights of the equity markets.
“Combined with the rising cost of borrowing, the commercial real estate industry will also need to adjust in the face of rapidly accelerating pandemic-driven trends in land use demand.”
Beacon Economics’ forecast suggests the economy will return to pre-pandemic levels of output by the 2nd quarter and be back on its long run growth trend in early 2022, much faster than the consensus outlook had predicted. The reason many forecasters got it wrong is because they were using past recessions as a comparison, a non sequitur as the pandemic was more like a global natural disaster rather than a traditional business cycle. Natural disasters, while tragic in human terms, have little long run economic consequences.
Despite the positive outlook, the commercial real estate industry faces substantial risks in the years ahead. Two major risk factors stem from excessive government stimulus and the acceleration of existing trends in land use. As for the stimulus, the excessively grim outlooks from public and private forecasters have spurred the Federal government to borrow at a truly unprecedented rate. The last fiscal year saw $3 trillion in new federal debt; as a percent of U.S. GDP, that is the highest since World War II. It’s likely that the current fiscal year will see over $2 trillion in new debt even without a second stimulus. This massive borrowing surge had little impact on interest rates because excess savings have been sufficient to meet the demand for capital. But 2021 will be a different story as savings start being used to fuel new spending. Combine this with the high rate of debt turnover given the high share of short-term debt being used to fund the current deficit, and interest rates will start to rise by the end of 2021.
Adding to the problem is a Federal Reserve that, through quantitative easing, is ‘stimulating’ like it’s 2009 even though it is not. During the Great Recession there was a collapse in household net wealth from the subprime inflated peak reached in 2007. This, combined with the massive loan losses suffered by the banking system, caused a cash crunch that the Fed had to aggressively respond to. Today there is no bubble, there is no collapse in wealth and the credit markets look solid, with only minimal increases in delinquencies outside the CMBS market. Hence this bout of quantitative easing by the Fed has caused the largest spike in money supply since the collapse of the Bretton-Woods system in the late 1960s – well over 20% in one year. This will surely lead to an increase in inflation if the Fed fails to withdraw some of this liquidity over the next year and cause interest rates to rise.
Combined with the rising cost of borrowing, the commercial real estate industry will also need to adjust in the face of rapidly accelerating pandemic-driven trends in land use demand. This includes repurposing excess supplies of retail space as purchasing moves online and adjusting to the decline in office space demand per employee as managers apply work-from-home strategies learned over the past year to allow more employees to work remotely. These trends are already being seen in the commercial industry through rising vacancies for office space and collapsing rents for retail. The long term solution to these issues is public land use reform, something that has become exceedingly complicated in today’s overwrought political environment.
In short—fear not 2021, the U.S. economy is on a clear path to recovery. Our collective concern should be focused on the years beyond as constant and stifling political partisanship leads to more inadequate policy and unintended consequences.
Christopher Thornberg is Founding Partner of Beacon Economics LLC and Director of the UC Riverside School of Business Center for Economic Forecasting and Development.