WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today and how strong are they?

Rebecca Rockey: The biggest headwinds facing U.S. commercial real estate are, oddly enough, tied to the exceptionally strong economy and its shifting path. Strong economic growth has helped, in part, fuel uncomfortable levels of inflation and the Federal Reserve has been clear that they intend to deal with it. This broadly means that they want to see demand in the economy (measured through things like GDP and job growth) slow from the frenzied paces recorded in 2021 and into 2022. This will inevitably result in a choppier and slower growth environment. We are seeing the “choppier” part play out in equity markets right now. Fortunately, for this year, taming demand means downgrading from what were fairly rosy expectations for the year. For example, the consensus for GDP growth in 2022 was 4.0 percent to 4.5 percent at the start of the year. Now, it’s more like 2.5 percent to 3.0 percent. This is still a great rate for the economy and for fundamentals. In short, the headwinds are not that strong now, but will get stronger throughout the year. But this is a necessary and healthy part of rebalancing supply and demand and bringing down inflation. It’d be much worse for commercial real estate to let growth and inflation get out of hand.

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Rebecca Rockey: Every recession is unique, and turning points are always hard if not impossible to predict. But we get some pretty clear warning signs, and so far, only a few are flashing red, most notably the stock market (which is not the best predictor, by the way). We’ve even had bear markets in equities without an ensuing recession. Despite every downturn being different, investors should look at a broad range of fairly reliable indicators to think about recession probability and when it may actually start. Lead times can vary from three to 18 months, so it’s helpful to watch a variety of data. The yield curve (using forward rates) is one useful tool, particularly the 10Y/3M and the 10Y/2Y spreads. Labor market metrics like the unemployment rate, initial claims and the employment gap are also going to be especially helpful today since this is one target of the Fed. Manufacturing activity will also display a marked decline prior to a recession.

WMRE: What advice do you have for commercial real investors and landlords in today’s environment?

Rebecca Rockey: I think the first thing for commercial real estate investors is to (always) remember that commercial real estate is not the stock market. Fundamentals closely relate to the real economy (albeit with some lags), even though credit and debt conditions are tied to the financial markets. Financial markets can move in ways that diverge from the real economy for periods of time, and we are seeing that a little bit right now. Interest rates and credit markets are doing some of the Fed’s work for it, and with that said, investors should definitely expect higher debt costs as a result. That is what matters for commercial real estate investors.

What is unique today, at least compared to the prior two recessions, is that a slowdown will not mean going back to the zero lower bound. Said differently, the Fed is not going to ride to the rescue at the first signs of market dislocation or even faltering growth. Quite the opposite, they are explicitly pushing for both in their efforts to reduce inflation. Investors have not had to deal with a situation like this in a long time. The so-called “Fed put” has bred complacency among investors over the last 10 years—and this does apply to both commercial real estate and the stock market—and there is the potential to get caught wrong footed if an investor does not internalize that financial conditions are going to be materially tighter and for longer.

There are a lot of reasons to believe that any future downturn would be limited in severity for the real economy. For starters, the banking sector’s capital position, household balance sheets—these are all in a healthy shape. Economy-wide profit margins were at a historic high at the end of 2021, with room to absorb some cost inflation. It’s unique that we are dealing with an economy and job market that are way too hot (hence inflation for the first time in 40 years). It’s been some time since we’ve had that issue. There is room to cool the economy down without derailing growth, and thus commercial real estate fundamentals, just yet. Be patient. Investors should remember that between rate hiking cycles starting and the subsequent recessions, GDP has grown by an average of 15 percentage. We’ve just started the hiking cycle, and many recession signs are not flashing just yet. Plan for a choppier environment, be choosier about locations and asset types and definitely plan for higher rates. There is always opportunity, even in down cycles.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why?

Rebecca Rockey: The fundamentals will remain strong for industrial almost irrespective of whether the economy goes through a soft or hard landing (i.e. recession). Multifamily also seems well-positioned for continued growth in cash flows, with low vacancy supporting effective rent growth across most markets. The caveat here is that with real incomes now falling, tenants will push back, and this could lead to further migration to lower cost markets and crimp household formation. There is also a supply wave coming in multifamily. Office is exposed to any slowdown since its recovery is ultimately contingent on job growth, regardless of where one falls on the wild card of hybrid work. Retail depends on consumption, which is extremely high right now and is going to be engineered down through monetary policy. As with overall growth, it will be coming down from a higher level, and offsetting slower growth or even a decrease are signs of a shift back to services in consumption. This will benefit retail. The other thing retail has going for it is an almost non-existent pipeline—the same cannot be true for any of the other major property types.

The trickier part for investors and what will impact whether a commercial real estate sector “thrives” from a return perspective are valuations. The cost of capital has increased materially and is likely to remain elevated—at a minimum, cost of the capital is not returning to 2021 levels any time soon. Some of the most fundamentally sound sectors (industrial, multifamily) are extremely exposed to these changes in cost of capital, and the market is only beginning to price the necessary adjustments. There will be investors who bought at very low cap rates last year who are going to see great NOI growth and yet lackluster returns.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Andrew Rybczynski: The three biggest headwinds facing U.S. commercial real estate today are the Fed, demographics and the prevailing desire for office workers to work from home. As inflation runs hot, the pendulum of the Fed’s dual mandate swings away from “maximum employment” and towards “stable prices.” Rate rises have started and the bond market expects more, with the express goal of the Fed to cool demand and thus slow inflation. While hope still exists for the mythical “soft landing,, whereby the Fed is able to raise rates enough to slow demand, but not so much that they impact GDP growth and the job market, the Fed has yet to actually walk that fine line. As such, the word recession is being thrown around a lot, and for good reason. With the potent tools the Fed has at its disposal, including the heretofore untested quantitative tightening, it can be safely assumed that if they’re trying to cool demand, they will be successful, and that includes demand for commercial real estate. There are a wide range of potential impacts on fundamentals, but no asset class would be unaffected.

Demographics are a longer-term threat to commercial real estate, but even in the near-term there is reason for concern. The U.S. is facing slow or no growth in most age cohorts, except for retirees. Growth in the younger side of middle-aged (40-49) powered by millennials will be offset by shrinking population in the older side of middle-aged (50-59) by gen Xers replacing the tail end of baby boomers. Younger cohorts are at best not expected to decline. Immigration has the potential to power a little more growth, but declines in the number of births that started in the Great Financial Crisis will start biting in the foreseeable future. Children born in 2008 are turning 14 this year, only four years out from the traditional age to start leaving the nest. Looking even more short-term, the number of 20-34 year-olds is already in decline (metro dependent—this is not the case in strong in-migration markets). While millennials are delaying the traditional trappings of adulthood, like marriage, children and crucially homeownership, a decline in the raw number of bodies is still cause for concern. Household formation and working age population growth are relevant to all property types, though especially office and multifamily. Again, immigration is a potential cure for these shortfalls.

Lastly, work from home is a meaningful risk for the office market. Office vacancy has been hovering a little above 12 percent for the last few quarters, and though demand growth has returned, there’s no sign of a big pick-up that will drop vacancies. Most likely the top tier of buildings, especially those with good environmental credentials, will continue attracting tenants, but in a less crowded marketplace there will be older buildings with obsolete amenities and floorplates that struggle to maintain occupancy. Other property types have been impacted by this shift as well. Urban retail will experience less foot traffic with less workers in the office, and urban multifamily would theoretically be less attractive as the premium paid for a short commute would no longer be as meaningful if that commute only happens two or three times a week. Suburban rent growth in multifamily has been consistently stronger than urban throughout the last two years, though urban multifamily has fully recovered in most parts of the country.

Nevertheless, work from home has the potential to reshape the office market and cause some meaningful value-loss along the way.

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Andrew Rybczynski: Some of the key lessons, around conservative underwriting and leverage, are not lessons that can be applied on the fly. The lead up to a recession is dangerous because in a heated market, investors are most likely to overextend themselves to get deals closed. There is hope that this will be a relatively light recession, though, and fundamentals in multifamily and industrial, the two space markets where yields got the most compressed, are extremely strong. Although a lot of deals got done in the last year, for most deals closed prior to 2021 this environment is probably outperforming projections. That creates a bit of a safety net wherein fundamentals first have to deteriorate to historical norms, and then deteriorate even further before a lot of investors start feeling pressure. Office properties are in an unenviable position as they would start a potential recession closer to historical vacancy highs.

WMRE: What advice do you have for commercial real estate investors and landlords in today’s economic environment?

Andrew Rybczynski: Think long-term and remember that the market in aggregate reacts slowly. There are inefficiencies to be exploited and while moving with the herd is defensible, it can blind you to other opportunities.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why?

Andrew Rybczynski: Industrial remains the best positioned property type on the strength of the secular shift to online purchasing. Although a wave of supply is underway, the market is at historical vacancy lows, and seems well-positioned to absorb it. Even in the face of recession, this is a growth industry.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Ryan Severino: First, the sudden rise in interest rates has caused some dislocation in the market. While commercial real estate typically handles rising rates with aplomb, the suddenness of the movement in Treasury yields has proven a bit disruptive. Second is what I will broadly call geopolitical risk. The war in Europe is highly unpredictable, COVID continues to evolve and evade defenses and lockdowns continue to disrupt production and distribution. Commercial real estate is not immune to these issues, even if risks are not evenly distributed across geographies and property types. The third headwind is the labor shortage. While part of the labor shortage is cyclical and associated with the pandemic, part of it is structural, associated with massive demographic change. The scarcity will challenge the overall economy and commercial real estate, particularly in the parts of the market that find the most difficulty in filling open positions and in the post-pandemic world where many are rethinking career choices.  

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Ryan Severino: The last two recessions make for bad benchmarks because idiosyncratic events caused significant shocks to the economy. If we are headed for a recession, it will likely look more like either the S&L crisis recession of the early 1990s or the dot-com recession of the early 2000s. More the classic recipe for a post-war recession in the U.S.—the Fed raising rates too much. It would be relatively short and much less severe than the prior two recessions in terms of the damage to the economy and the commercial real estate market.

WMRE: What advice do you have for commercial real estate investors and landlords in today’s economic environment?

Ryan Severino: Think medium to long term. The most probable outcome of the current environment is a soft landing—either the Fed will land the plane safely, or we will end up in a short and shallow recession. Either way, as long as investors avoid some kind of event risk—a big lease rollover, loan maturity, etc.—commercial real estate should handle that landing well and then be off and running again through the next reacceleration in the economy. The risk is more about timing than the merits of the asset class itself, which continues to prove its worth over time.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why? 

Ryan Severino: In the short term, it is hard to argue against strong, defensive sectors like apartment and industrial. We simply aren’t building enough housing units in the U.S. to keep up with demographically driven demand. Estimates vary, but we are in a housing shortage that will not get fixed in the short run. For industrial, while the shift toward more goods consumption isn’t fully permanent, it will take a while for consumers to readjust back to pre-pandemic norms, especially if the pandemic lingers on a while longer. That suggests continued demand for industrial while supply will struggle to keep up with demand in many markets in the short run.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Kevin Brown: Higher interest rates. Given the capital-intensive nature of investing in commercial real estate, nearly all real estate owners must utilize debt to finance a significant portion of the investment. Therefore, if interest rates go up and stay at the new, higher level for an extended period of time, then real estate owners will face ever-increasing interest expenses as current debt comes due and must be replaced with higher-rated debt. However, given that most owners stagger their debt maturities that increase will be gradual. The larger, more immediate impact will be on owners that are actively expanding or recycling their real estate portfolio. Owners actively acquiring or developing new properties compare the expected acquisition cap rate or development yield to their weighted average cost of capital before they move forward with the investment. Higher interest rates raise the WACC, which in turns reduces the expected return on the acquisition or the development project. Not only do lower returns hurt the acquirer, but they also hurt the seller as there will be less demand for the property being sold, which potentially lowers the asking price for the property being sold. Therefore, higher interest rates will have a larger impact on active real estate investors compared to ones with static real estate portfolios.

Higher operating costs. Inflation has caused nearly all operating cost categories to go up significantly over the past year and that looks to continue through the rest of 2022. However, this has a disproportionate impact based on the real estate sector. On one end are real estate owners that have triple-net operating leases with their tenants as they require the tenant to pay nearly all of the operating and maintenance expenses for the building. Mall owners will also see a smaller impact as they typically bill each tenant a proportionate share of the mall’s total operating costs and expenses. However, more operationally intensive sectors will see their cashflows negatively impacted by higher operating costs. Hotels and seniors housing both operate at lower EBITDA margins than most other sectors, with a large percentage of their costs coming from labor, so wage inflation may cause operating margins to fall.

Tenants facing higher costs. While higher operating costs are either passed along to the tenant or can be offset by higher rents for most sectors, landlords need to worry about the health of their tenants and if they are able to bear the brunt of higher costs. Tenants in many sectors, such as large retail anchors or skilled nursing facility operators, operate at single-digit margins, so even small increases in costs can affect the profitability of those tenants. Real estate landlords will have a difficult time passing along rent increases on tenants with very low operating margins and may face occupancy declines if higher costs cause many to be unprofitable, forcing the tenants to close down or move out. Therefore, while not all real estate sectors are negatively impacted by higher inflation, many will find that inflation does put a cap on how quickly they can raise rents.

If we do enter a recession in the next 12 to 24 months, we don’t anticipate it will be like the prior two recessions. Those recessions were both event-driven and we don’t anticipate the U.S. entering those situations again. If we do face a recession, we wouldn’t expect it to be either severe or long lasting. The most likely cause would be over-tightening from the Fed, which means that economic activity could quickly rebound as the Fed course corrects. While tenant might have their cashflows negatively impacted by a recession for a short period of time, the long-term leases for most real estate sectors should protect rent payments. Additionally, while the number of bankruptcies might increase and potentially cause retail occupancies to fall, we don’t anticipate a significant drop in occupancies, given the current health of most retailers. The mall REITs just reported that occupancy costs… are at the lowest point in six years, suggesting that tenants can absorb a short-term drop in sales from a mild recession before they move out. So, while a recession might force some tenants on the margins to move out, we don’t anticipate it having a major impact on most landlords.

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Kevin Brown: The biggest lesson I think landlords learned from the ‘08-’09 financial recession was that high financial leverage can be dangerous. Many landlords were over-levered prior to the recession, so when debt markets froze, many were forced to sell assets at significantly reduced prices just to pay off maturing debt. Most landlords learned their lesson and as a result entered the pandemic with significantly lower leverage. Therefore, despite cashflows to real estate owners seeing a much larger decline during the pandemic, there were far fewer forced asset sales. Since the financial leverage situation remains similar today as it was during the pandemic, we believe very few landlords will be forced into a situation where they must sell assets to cover operating expenses or pay off maturing debt.

Given the large, illiquid nature of the asset class, real estate investors should remember to focus primarily on the long-term fundamentals and health of the sector and not get caught up in any short-term fluctuations. Many real estate sectors are seeing record levels of net operating income growth as either they are recovering from the pandemic [or] some additionally benefitting from high levels of inflation translating to high rent growth. Conversely, a potential recession could cause a slowdown in NOI growth for several quarters. Investors should focus on where these sectors are going to level out once all of the current economic turmoil subsides to determine which sectors could potentially generate the highest returns.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why? 

Kevin Brown: We think the best real estate sectors over the next 12 to 24 months are ones where demand is not highly correlated with economic growth and sectors with short lease terms that can quickly turn high inflation into higher rents.

The top sector that stands out with these attributes is the self-storage sector. Demand for self storage is countercyclical as increased disruption in the economy and in people’s lifestyles leads to more movement of the population and thus more demand for storage. Lease terms are also typically very short, so many self-storage owners have been able to turn the high inflation levels into double-digit rent growth.

Another sector that should do well is seniors housing. The correlation between economic growth and demand for the sector is low because when seniors have medical needs that exceed the ability for them and their families to provide [for them], then a move into a seniors housing facility is almost a necessity despite economic circumstances. The sector is still recovering from the pandemic, so while occupancies are currently low, they should continue to grow even if the country experiences a mild recession. Demand is also growing at an accelerating pace as baby boomers reaching the target age of 80. Finally, leases are typically only for a year at a time, so rising operating costs can be passed along relatively quickly as higher rents.

Finally, we think multifamily should perform well over the next several quarters. While demand is more correlated with economic activity than seniors housing, everyone still needs a place to live and with lease terms of only a year that should allow the landlords to quickly pass along rent increases. Additionally, a recession may cause millennials to put plans to buy a new home on pause, delaying that potential headwind for the sector by another year or two.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Martha Peyton: First is the slowdown in economic growth and the possibility of recession. This headwind is strong even if recession does not materialize in a technical sense in 2022 to 2023; economic growth is slowing sharply. Early this year, much stronger growth was expected flowing from a slow petering out of the impact of COVID relief policies. Decisions made based on that expectation are now proving to be overly optimistic. But new supply in the construction pipeline is generally modest, suggesting that weaker demand will not be catastrophic even if returns are stressed over the quarters ahead.

Second is the surge in inflation and the impact of the U.S. Federal Reserve’s efforts to squash it. The surge in inflation related to construction materials and labor has been at play for many months and has slowed the pace of construction. Higher interest rates and slower growth will suppress it to some degree. But the disruption in global trade due to COVID and the war in Ukraine is also playing a part; there is no way to predict a resolution. Wider inflation is raising operating costs, especially related to energy. Higher interest rates are raising borrowing costs. Historically, U.S. commercial real estate investment returns have beat inflation when evaluated over typical five-year holding periods.

Third is the “net zero carbon” challenge. Many investors have pledged to achieve net zero carbon, but doing so is challenging. Retrofitting properties can be costly or even impossible for certain structures. Only a small portion of the property stock is new construction built to current standards; the vast bulk is legacy property constructed before climate awareness arose. Property owners and investors are challenged by the need to respond to current conditions, which may delay or even preclude responding to climate change which is a commonly seen as a longer-term risk.

WMRE: If we are, in fact, heading towards a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Martha Peyton: The lessons learned include avoiding the tendency to reach for return as the cycle nears a peak. Adding more leverage and/or shortening the maturity of borrowing is a typical ill-advised tactic. In many ways, the current situation is unique, particularly regarding the office property sector. As economic growth slows, it will take tenants longer to assess their space needs in the “hybrid” working environment.  

WMRE: What advice do you have for commercial real estate investors and landlords in today’s economic environment?

Martha Peyton: Find confidence in remembering that past recessions have impacted U.S. commercial real estate in proportion to the demand-supply imbalances in local markets. Currently, apartment, industrial and neighborhood retail have few pockets of imbalance, with office market balance unknowable due to ongoing COVID work-from-home disruption. We believe the general absence of over-supply and over-construction will constrain the stress from slower growth and higher interest rates.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why?

Martha Peyton: Apartments with market-rate rents affordable to middle-class renters remain in very short supply. Rent growth at the long-term inflation rate should be possible to achieve over an investment horizon. Neighborhood retail in localities that have seen strong population growth is attractive as well.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Darin Mellot: Inflation, interest rates and uncertainty. There are elements of geopolitical events and COVID-19 that we can’t fully predict, and this uncertainty will have an impact on inflation and how the Fed responds. While we see headwinds building, we think the brunt of the impact will be felt later in the year and going into 2023. That’s when we’ll more fully see the impacts of rising rates.

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Darin Mellot: First, a recession isn’t a foregone conclusion at this point. While there are some scenarios that would allow a soft landing, we fully recognize the buildings risks. That said, it’s important to remember that no matter what the market conditions, there are always opportunities. It’s a matter of being in the right position to take advantage of those opportunities. Furthermore, each downturn is different. People have a tendency to fight the last battle instead of recognizing what’s different.

WMRE: What advice do you have for commercial real estate investors and landlords in today’s economic environment?

Darin Mellot: It’s important to be able to play offense and defense in times like this. While the environment is dynamic and you have to be more strategic in moves, there are always opportunities. One of the things I will often hear is that people wished would have made moves when … name your period of crisis or uncertainty.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why?

Darin Mellot: Multifamily will thrive because there’s currently a shortage of housing in the U.S., the labor market remains strong and single-family housing affordability will be an even bigger problem with interest rates increasing. So, you have tailwinds on the supply and demand side that are positive for multifamily. That’s not to say the segment won’t be impacted by headwinds later in the year, but overall, the picture is broadly favorable. Across other property types, there will still be attractive opportunities. Retail hasn’t seen much in the way of supply over the last decade, offices that can cater to new ways of working will be well positioned and we still see strength—even if there is some cooling—across industrial and logistics markets.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Kevin Fagan: First, inflation and interest rates put pressure on values, but commercial real estate can generally serve as an inflation hedge when rent growth can mute implied value declines of rising cost of capital. Lower demand commercial real estate assets, or even high demand assets that are already priced very tightly, could suffer nonetheless, hence we’ve seen a flight to “safety” asset classes like multifamily and industrial over the last year. Second, consumer sentiment and expenditures are slowing, exemplified by the recent pain reported by many national retailers. This could result in a drag on more consumer-oriented property types like retail and multifamily. Third, the rising risk of a recession.

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Kevin Fagan: Every recession is unique, so it is always difficult to predict how exactly it will impact commercial real estate. For example, the 2020 recession was extremely different for commercial real estate [versus] the 2008 recession. From a lender perspective, the next recession would presumably be smoother for commercial real estate, as there are generally lower leverage loans on most properties. For example, CMBS loans have averaged around 61 percent LTV this cycle compared to about 72 percent pre-2008 financial crisis. However, the implied leverage could be much higher, and risk much greater in a recession, for the many assets that have a lot of subordinate debt or were aggressively priced.

WMRE: What advice do you have for CRE investors and landlords in today’s economic environment?

Kevin Fagan: For equity investors, it’ll be important not to get wrapped up in the euphoria of “safe” asset classes. If they plan to hold assets over the next five years or so, they should avoid underwriting the unsustainable rent growths that occurred in 2021, like the [more than] 12 percent record average annual rent growth for multifamily, and it would be prudent to assume a somewhat higher reversion cap rate because of upward interest rate pressure. Investors in commercial real estate in general should also consider that the 2020 recession was unique in that it did not spur a liquidity crisis. While there was a barely interrupted flow of capital into commercial real estate over the last two years, that could change given a more typical downturn, for which some safety-net cash to bridge the gap is always a good idea.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why?

Kevin Fagan: Generally, multifamily and industrial still have a significant gap between demand for space versus new supply being delivered, which will support these sectors on average. Anchored and experiential retail in areas with strong demographics will continue to build on its recovery out of the pandemic. While the sector overall is unlikely to “thrive” in the near term, many high-quality office properties may perform well as firms return and remember the importance of in-person working and the need for quality office space. Flex office (i.e., co-working) space is likely to thrive. The need for flexibility is rising, and the curated “enterprise” solutions provided by a myriad of operators beyond WeWork will be increasingly attractive for both corporate tenants and building owners.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Mark Stapp: Materials costs (new construction and TIs), interest rates and market conditions related to uncertainty about global conflict(s). Supply chain issues continue to impact costs and schedules and these issues will not be resolved for several quarters, if not years. The Russia-Ukraine war and potential expansion of that conflict will have global impacts for a long time; some were immediate (gas prices) and some are just recently being felt.

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Mark Stapp: The conditions of the commercial real estate industry are very different from those in the mid-2000s. More capital available for investment, more real demand (demographics, lifestyle changes and technology impact each segment in different ways) and better balance sheets are positive factors that will allow the industry as a whole to weather a recession and likely emerge in decent condition. But certain markets and property segments will be negatively impacted, while others will continue to remain solid.

WMRE: What advice do you have for commercial real estate investors and landlords in today’s economic environment?

Mark Stapp: Be cautious over the next 90 days. There are too many unknowns when underwriting assets, including costs. Demand is high, but costs are making some projects unfeasible, and affordability is a real concern. Certain opportunities were saved by cap rate compression and rising rents, which more than off-set cost increases and schedule delays, but rising interest rates, elastic rents may not provide same mitigation and certainly should not be what to bet on. 

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why?

Mark Stapp: The industrial sector is most likely to thrive because of continued strong demand related to consumer spending, changing/evolving business and operating models, onshoring and increases in manufacturing. Apartments are also most likely to thrive because everyone needs to live someplace, inventory is still well below demand and rising interest rates will push more people to rent—issues will be affordability and rent increases.

WMRE: What are the three biggest headwinds facing the U.S. commercial real estate industry today?

Larry Kay: One of the strongest headwinds are rising interest rates, which are increasing borrowing costs and could potentially limit liquidity and transaction activity. A slowing economy/recession, which could result in a curtailment in consumer spending, business production and hiring and lead to less tenant demand. With weaker tenant demand, the commercial real estate sector could see rising vacancy rates and less rent growth, which will vary by sector and market. [There’s also] a continuation of high inflation from labor shortages, gas prices and supply chain disruptions.

WMRE: If we are, in fact, heading toward a recession, what lessons can commercial real estate investors and landlords apply from previous recessions?

Larry Kay: If we do enter a recession because of rising inflation and global economic disruptions from the war in Ukraine and China’s strict COVID lockdowns the causes are certainly unique. This makes it hard to predict what will happen. However, since the Great Recession loan origination standards have remained disciplined, which will help limit negative impacts. Poor origination quality on commercial real estate loans contributed to the severe credit impact of the Great Recession. While the COVID-induced economic recession was meaningfully different than the Great Recession, the pandemic’s impact on commercial real estate usage was extremely severe. Many properties went unused or were underutilized for significant durations. In addition, during the Great Recession, there were weakening property fundamentals, as well as market illiquidity and falling property values.

WMRE: Which property types are most likely to thrive over the next 12 to 24 months? Why?

Larry Kay: Multifamily and industrial. With mortgage rates rising, there should be increased demand for multifamily housing. In addition, with the escalation in single-family home prices, affordability is an issue, and potential home buyers that have been priced out of the market should prop up demand for multifamily. In addition, demographic trends including baby boomers that are downsizing and millennials forming families should continue to support multifamily demand fundamentals. There continues to be more demand than available supply, which should lead to higher rents.

Demand for industrial space remains strong, with the growth in e-commerce expected to continue. Logistics and last mile industrial distribution centers are experiencing strong tenant demand from operators fulfilling online orders. High oil and gas prices should increase the demand for those warehouse facilities that are near urban centers and can provide same-day delivery. While supply is increasing for industrial properties, it will take time to absorb the additional space, which should continue to support rents and occupancies.

In addition, there are emerging in-demand asset classes, such as build-to-rent single-family developments, life science properties and data centers, provided they are strategically located.