Recession Fears Keep Hovering Over Commercial Real Estate Market
The Federal Reserve’s decision to cut interest rates Wednesday for the first time since the Great Recession may embolden investors, but experts at Bisnow’s Chicago Capital Markets and CRE Finance event still sounded a few warnings about the city.
McCaffery Interests Senior Managing Director Clayton McCaffery, a panelist at the event, was asked by Siegel Jennings partner Molly Phelan, who moderated, whether there are any property types investors should avoid.
“Anything with a tax bill,” McCaffery said.
He believes the recent moves by new Cook County Assessor Fritz Kaegi to overhaul the local assessment process, and the likelihood of higher taxes on commercial property, has spooked potential investors.
“In my conversations lately, that has been the driving topic.”
Zeller Realty Group Chief Investment Officer Bill Rogalla is seeing the same nerves.
“With investors, it takes about five minutes for taxes to come up,” he said.
The uncertainty over what Kaegi plans may be more concerning than any tax hike.
“There just isn’t any understanding of what the endgame is going to be,” McCaffrey said.
Kaegi told Bisnow these changes are needed to more fairly distribute the county’s tax burden, and lift some of the weight off homeowners. He also believes a more transparent assessment system will better enable commercial property owners and investors to predict their tax rates and plan accordingly.
BMO Harris Bank Director of Real Estate Finance Jerry Lumpkins is already planning ahead. As possible Chicago-area deals cross his desk, the bank estimates future tax bills conservatively, so there are no nasty surprises over the next few years.
Phelan echoed the concerns of the panelists, but also believes commercial property owners have cards to play. The assessed value of many commercial properties in northern suburbs like Evanston, which just underwent scheduled assessments, may have doubled, and a similar result may occur when Chicago gets a new assessment in 2021, she said, but municipalities haven’t decided what actual taxes will be, and owners can also file appeals.
“We still have the Cook County Board of Review, and we still have the law,” she said.
Anxiety that this level of uncertainty will put a damper on investment may be overblown, several panelists added.
Rogalla pointed to the healthy leasing at the 2.5M SF Old Main Post Office restoration as just one of many signs the office market will keep growing. And though a number of other trophy projects, such as 110 North Wacker Drive, will soon deliver, the rate of new construction remains below what it was in previous boom times, and is unlikely to upset the balance between supply and demand.
Other Chicago sectors have a lot of fans as well.
“In spite of the worry over taxes, and the fear of fiscal disaster, I constantly get calls from institutional investors in New York, Seattle and even international ones, who are interested in apartment buildings,” Lumpkins said.
“There is still abundant equity and a lot of very attractive debt,” Rogalla added.
Concerns that President Donald Trump’s barrage of tariffs could have a negative economic impact, perhaps even help push the global economy into a recession, still hover over the entire U.S. Property owners don’t seem to be hunkering down, but it is shifting their strategies.
In the past 12 months, investors have increasingly asked for flexibility, instead of locking in rates for the long term, even if that involves more risk, according to John Hofmann, who handles originations for KeyBank.
“I’m told, ‘I’d rather be able to sell my building quickly, once we execute our business plan,’” he said.
Barings Real Estate Advisers Managing Director Pam Boneham added that fears over the trade war have had a major impact on business outlook, and could set the stage for a recession. She pointed out that Moody’s Analytics found global business confidence to be at a 10-year low on June 28.
But in the past few weeks, confidence did return to where it had been earlier this year. Moody’s attributes this recovery to a momentary truce on tariffs between the U.S. and China after a July summit between the two countries (though then Trump announced new Chinese tariffs Aug. 1), and an easing of interest rates by many central banks, with the Federal Reserve being just the latest to announce a cut.
Hofmann still sees other worrisome signs. Corporations are carrying a lot of debt, he said, and debt markets may not hold up well if the economy slumps.
“We are poised for some correction,” Lumpkins said.
McCaffrey has witnessed an accelerating compression of what people in the commercial real estate industry consider good returns. And as those returns keep shrinking, the costs of everything, including building materials and labor, continue to rise, and in turn puts more downward pressure on returns.
“At some point, there’s going to be a straw that breaks that camel’s back.”