(December 12, 2023) – Colliers’ research team is reporting momentum waned across all commercial real estate asset categories, with some experiencing more pronounced declines than others in 2023. The speed at which the Federal Reserve raised rates after the ultra-low-interest rate years brought the once red-hot capital markets sector to a standstill. Meanwhile, any positive momentum in the office sector in 2022 was diminished in 2023, when more than 70 million square feet of negative absorption was recorded over the last four quarters.
Eighteen months earlier, the U.S. economy reached an inflection point as fiscal and monetary policy decisions enacted during the pandemic came home to roost. After CPI inflation steadily rose throughout 2021 and 2022 to peak at 9.1% in June 2022, the Federal Reserve finally embarked on the fastest and most aggressive rate tightening period in over four decades.
Despite the multiple rate hikes, inflation persisted last year, but the labor market was strong, and spending was robust. While most of Wall Street began to brace for a hard landing in 2023, that failed to materialize. Instead, fueled by strong consumer spending and inventory investment, real gross domestic product (GDP), the scorecard of economic health, beat industry forecasts and increased at an annual rate of 5.2% in the third quarter of 2023, right after a 2.2% increase in GDP during the first quarter and a 2.1% rise in the second quarter.
Although the U.S. economy exceeded expectations in 2023, considerable uncertainty about its future is based on several challenges: the impact of the resumption of student loan repayments, congressional dysfunction and a potential government shutdown in January, expanding geopolitical tensions, and a tenuous banking situation. Reducing excess savings and rising delinquencies on auto loans and credit cards, combined with stringent fiscal and monetary policies, will further strain the economy.
Trends to Watch in 2024
- Consumer Spending to Wane: Consumer spending, the primary catalyst of the post pandemic economy, accounted for more than two-thirds of U.S. economic activity. Oxford Economics estimated that households had roughly $1 trillion in excess savings at the end of August; however, lower- and middle-income households have all but exhausted their savings, leaving the balance in the accounts of the upper-income households who are likely to view savings as wealth, not discretionary funds. As a result, Oxford Economics anticipates GDP growth of just 0.2% in 2024, followed by 1.6% growth in 2025.
- A Return to 2% Inflation?: Stabilizing gas and energy costs, falling auto prices, a housing index pointing to further declines in shelter inflation, and easing supply chains will continue to propel the U.S. economy’s disinflationary trend. However, with the Core PCE Annual Price Index standing at 3.5% at the end of November, the Federal Reserve’s 2% target rate likely won’t be reached until 2025.
- Higher For Longer: July likely signaled the conclusion of the latest Federal Reserve interest rate increase, elevating their target range to 5.25% to 5.5%. Although recent economic data support the Fed’s growing confidence that its restrictive monetary policy is feeding through the economy, it continues to emphasize a “higher for longer” approach and will be in no rush to cut rates. We anticipate that the Federal Reserve will shift its approach in the summer, opting for a gradual and purposeful reduction trajectory, potentially slower than in the past.
- Labor Market to Soften: After bottoming at 3.4% in April 2023, the unemployment rate climbed 50 basis points through November. While another 75-basis-point rise in 2024 seems manageable, larger concerns are the labor force participation rate, which has yet to reach pre-pandemic levels, and the mounting impact of retiring Baby Boomers on a softening labor market.
- Higher Cost of Capital: The Fed’s aggressive rate hikes over the last 18-plus months have dramatically altered the cost of capital. Higher interest rates impact acquisitions and refinancing and influence the ability to increase inventories, buy additional equipment, and finance tenant improvement allowances. While the markets began to price in interest rate cuts in June, it will take considerably longer to get capital flowing freely.
- Insurability: The National Oceanic and Atmospheric Administration (NOAA) reported 23 U.S. weather disasters with damage of at least $1 billion year-to-date in 2023, the most in over 40 years, and the ninth consecutive year with more than ten $1 billion disasters. Landlords will continue to face rising insurance premiums as providers limit their exposure in high-risk coastal and mountain areas in states like California, Florida, Louisiana, and Texas.
- Artificial Intelligence: Although artificial intelligence dates back to 1956, recent advancements in AI are ushering in a new era of technology tools poised to transform the commercial real estate landscape. Harnessing AI will enable the industry to gain in terms of efficiency, accuracy, workflow automation, and the ability to make data-driven decisions, ultimately enhancing the overall value proposition for stakeholders.
- Commitment to ESG and DEI: Commitment to Environmental, Social and Governance (ESG) and Diversity, Equity and Inclusion (DEI) policies will scale up as tightening regulations, a war for talent, and public scrutiny of businesses drive their adoption.
View the full report and individual market predictions here: Outlook 2024: Navigating Equilibrium, Distress, and Anticipated Policy Easing in Commercial Real Estate | Colliers