Where are we headed towards in the real estate market in 2023 and beyond?

I wanted to take a little bit of time to share some of my thoughts on where we’re heading in the real estate market. As a real estate tax consultant, I get this question a lot from everyone I know and I figured in the interests of saving time, I can just point them to this page and then take the extra time saved explaining this to instead work on writing more of these posts for you and delivering valuable information.

Let’s start first with the state of the overall economy in the US

The Economy

What a black box and self-contradicting bucket of facts the concept our of economy is. On one hand, we apparently have run away inflation, which is causing prices to soar across all categories. There are a million fingers to point to the cause of this inflation, from the fed’s overly drawn out dovish monetary policies to the US government injecting way too much liquidity into the system vis-a-vis tax breaks, PPP Loans, and other lending facilities. Then there’s the war in Ukraine which is putting pressure on oil and then Saudi Arabia announcing they’re cutting production to keep the price per barrel very high.

At the same time, we’re seeing massive rounds layoffs in the tech industry, which apparently is a sign of worsening labor conditions, except for the fact that these same workers are more or less being absorbed in other industries without much difficulty. Then we have the banking failures at Silicon Valley Bank and Signature Bank (and maybe First Republic) which apparently is, and somehow isn’t according to the Treasury Department, an indication that there is trouble in the banking sector as a result of the Fed’s very aggressive interest rate hikes over the past year.

Confused? Me too. I feel bad for highly trained economists for having to answer where our economy is headed. I also am very skeptical of anyone who claims to definitively know the answer. But one thing I do feel strongly about is that we’re going to be headed into some turbulent times and our government will struggle to respond since their revenues are too dependent on inefficient tax and budgetary policies, which is what California is learning right now with their current budget deficit. I suppose we can just print more cash to solve the problem, but then we’ll be back to that nasty little inflation problem we discussed earlier.

Office and Retail Demand

This appears to be in dire straits. Unless your office building or retail location is amongst the most prime of prime places to be, you’re in for a world of hurt. I don’t need to repeat the whole work from home movement (and apparently counter movement) that’s happening right now in the workplace, but it seems like overall, demand for offices and retail will be permanently impaired. These properties run the greatest risk of moving into defaults and being foreclosed on by banks, as the larger sized properties tend to be financed with short term hedging instruments, such as rate swaps, which the cost to maintain has skyrocketed over the past year. The combination of higher financing costs and higher vacancy will create a very bad set of conditions for these asset classes.

Residential Demand

The demand for housing appears to be insatiable, however there are a lot of countervailing forces at work here which will create an uncertain future for this sector. On one hand, with demand far outpacing supply (a lot of which I’ve addressed in this article here), there will be upward pressure on housing prices for quite some time. On the other hand, interest rates have nearly tripled from the lows of late 2021/early 2022 which should theoretically put downward pressure on pricing. Except for the fact that anyone selling a home has little incentive to do so because nearly every single home loan in the US is locked in at sub 3% APR for the next 30 years. This translates to far lower inventory levels since nobody wants to sell which then translates to supply again being outstripped by demand.

On the apartment front, again we’re seeing a case of not enough units being built to meet demand. Since housing inventory is lower overall, that means tenants will need to rent. Again, since interest rates are up, cap rates are up as well which is pushing valuations way down. Further, in response to rising housing costs, cities and states around the country are responding with rent control measures which will disincentivize further construction efforts from developers. Coupled with rising construction costs, it’s a very challenging time right now to deliver more apartments to the market. While it’s true that we’re supposed to see record deliveries of apartment units in 2023, this is not a uniform concept across the whole country. In places like California, we’re still short and will be for all eternity. So overall, a very mixed bag.

The Future

Everything I’m saying above doesn’t really paint a clear picture of where we’re heading. Therefore, I have to take a risk and hazard a guess on where I think we’ll be based on my experience as an amateur real estate economist and policy wonk. In my opinion, less than prime office and retail locations on floating rates will be absolutely crushed this coming year and you will see a tide of these properties changing hands, whether by sale or foreclosure.

On apartments, I believe we’ll see movement here no earlier than 2027, since a lot of the fixed rates will start to reset around then. At the moment, multifamily owners on fixed loan rates have no incentive to sell their properties as long as they positively cash flow, even if their overall value on paper is down.

On the housing side, I don’t see any significant movement on pricing under current economic conditions. I believe it will take a huge catalyst like a major recession and unemployment skyrocketing to see homes start to change hands.

I say everything above with the caveat that the fed holds interest rates roughly at these levels. If the fed cuts rates, we may see more trades happen and the market conditions loosen up. If they raise it much further, then honestly I have no idea what to even expect. Probably lots of misery.

Good luck everyone in this wild and crazy market. If you need a therapy session with me on the state of our real estate market, then reach out to me here.

-Stephen Morris, CPA, MBT, CCIM