Global Economic Stress Eases Despite Prospect of U.S. Recession

Although progress has been made in slowing inflation, the core Personal Consumption Expenditures (PCE) Price Index in the U.S. remains too high. While leading indicators suggest that core PCE will soon drop significantly, there is a chance that the Federal Reserve will lift interest rates by another 25 basis points (bps) in June. Likewise, the European Central Bank has indicated that more rate hikes are planned to cool the record wage growth in Europe. Inflation has been even harder to tame in Europe, with still rising core inflation ensuring that monetary tightening will continue (Figure 4).

Figure 3: PCE/CPI Inflation (Y-o-Y)

Source:: U.S. Bureau of Labor Statistics, Bureau of Economic Analysis, CBRE Research, Q1 2023.

Figure 4: U.K. & Europe Core Inflation (%)

Source: China Federation of Logistics & Purchasing, CBRE Research Q1 2023.

A strong labor market continues to undermine the fight against inflation in both the U.S. and Europe, with unemployment at cyclical lows in both regions (Figure 5). Along with weak productivity growth, this has pushed up labor costs, meaning that the unemployment rate will need to increase to rein in inflation. The challenge for the U.S. Federal Reserve and European Central Bank will be to engineer this scenario without causing a major recession.

Figure 5: Unemployment Rates (%)

Source: BLS, CBRE Research Q1 2023.

With the Fed mindful of not repeating the mistakes of the 1970s when the central bank failed to tighten monetary policy long enough to curb runaway inflation (Figure 6), interest rates likely will remain high throughout 2023, contrary to market expectations. Why has inflation been so difficult to control? While pandemic fiscal stimulus and the war in Ukraine are key factors, the delay in raising interest rates during 2022 is increasingly seen as a policy failure (Figure 7).

Figure 6: U.S. CPI Inflation (Y-o-Y%)

Source:: U.S. Bureau of Labor Statistics, CBRE Research, Q1 2023.

Figure 7: U.S. Federal Funds Rate

Note: Forecast Interest Rate determined using the CME FedWatch Tool with the highest probability. *Taylor Rule is a monetary policy targeting rule that calculates what the interest rate ought to be given current level of output gap and inflation.
Source: Federal Reserve, CME, CBRE Research, Q1 2023.

CBRE expects that a moderate recession will take hold in the U.S. by midyear, which should suppress inflation by increasing the unemployment rate and lowering wage growth (Figure 8).

Although Europe and the U.K. have been on the brink of recession, a recent drop in energy prices has boosted consumer and business sentiment. As a result, CBRE expects economic growth will stagnate in the region rather than tip into recession over the next 12 months (Figure 9).

Figure 8: U.S. Quarterly GDP (Y-o-Y) & Trend GDP

Source: CBRE Research Q1 2023

Figure 9: U.K. & Europe Quarterly GDP (Y-o-Y) & Trend GDP

Source: CBRE Research Q1 2023

Despite less trade with the U.S. and Europe, none of the major Asia-Pacific economies except for Australia likely will have a recession. China’s stimulus, loose monetary policy and economic recovery will ensure that growth in the region outperforms the U.S. and Europe this year and next.

Consumer spending in the U.S. and Europe remains resilient, with U.S. consumer wealth in relatively good shape (Figure 10) and both regions unlikely to see substantial reductions in spending.

Figure 10: U.S. Household Net Worth Index (Jan. 2005=100)

Note: The model assumes 50% stock and 50% home.
Source: CBRE Research Q1 2023.

The collapse of Silicon Valley Bank and Credit Suisse’s takeover by UBS in March sparked fears of financial sector contagion and led to U.S. listed financial stocks falling by 12% for the month (Figure 11).

Figure 11: S&P 500 Sector Performance in March 2023 (%)

Source: Macrobond, CBRE Research, Q1 2023.

Regulators moved quickly to contain the crisis. The U.S. Federal Reserve launched the Bank Term Funding Program (BTFP) on March 12 and issued a joint statement with the U.S. Treasury Department and Federal Deposit Insurance Corporation guaranteeing that Silicon Valley Bank depositors would have access to all their money (Figure 12). In Europe, the Swiss government facilitated UBS’s takeover of Credit Suisse, which was partly funded by a loan of 100 billion Swiss francs.

Figure 12: U.S. Federal Reserve Total Assets ($ Billions)

Source: The Federal Reserve, CBRE Research, Q1 2023.

Many smaller regional banks have been lending freely in recent years and have played an important role in providing credit for commercial real estate acquisitions, residential mortgages and small businesses. While there is no undue concern that these institutions have been lending recklessly, they do have high loan-to-equity ratios and considerable exposure to real estate (Figure 13). Many have curtailed their lending, which will create a slight credit crunch in the U.S and negatively impact financing for real estate.

Figure 13: Percentage of U.S. Bank Loans for Commercial Real Estate

Note: Large banks are defined as the largest 25 commercial banks in the United States. https://www.federalreserve.gov/releases/lbr/current/
Source: The Federal Reserve, CBRE Research, Q1 2023.

Broader indicators are not signaling risk of a major financial crisis, with the AAA & BBB rated corporate bond spread over 10-year Treasury bond yields up slightly (Figure 14). An excessive widening of spreads indicates heightened economic risk. The bond spread in Europe, another generalized risk indicator, also is not particularly high (Figure 15).

Figure 14: AAA & BBB Rated Corporate Bond Spread Over 10-year Treasury Bond Yields

Source:: Macrobond, CBRE Research, Q1 2023.

Figure 15: 10 Year Government Bond Yield (%)

Source: Macrobond, CBRE Research, Q1 2023.

The higher cost and limited availability of debt capital, along with uncertainty over property pricing, will weigh on commercial real estate investment activity across all regions in 2023, with CBRE expecting total global volume to fall by 26% before rebounding by 13% in 2024 (Figure 16).

Figure 16: Global Real Estate Investment Volume ($ Billions)

Source:: CBRE Research Q2 2023.

Any increase in commercial real estate investment volume will depend on several factors. Prices must fall a little more and offer higher initial yields to provide an attractive return over those available from bonds. A clear signal of the peak of the rate cycle is needed from inflation data and central bank statements, which we expect most likely will occur by the end of Q3. Finally, a reasonably clear view of improving real estate market fundamentals is required, which likely will come first in the multifamily and industrial sectors.

Figure 17: All-Property Yield & Global Bond Rate Spread

Source: CBRE Research, Q1 2023,

Office cap rates have increased the most since last year. Europe had the biggest increase, despite the strong performance of many office markets in the region (Figure 18). Industrial cap rates had the least movement, reflecting investors’ continued confidence in sector fundamentals (Figure 19).

Figure 18: Office Cap Rates by Region

Source: CBRE Research Q2 2023.

Figure 19: Industrial Cap Rates by Region

Source: CBRE Research Q2 2023.

Retail cap rates began increasing in Q1 2020 when the COVID pandemic began and remain relatively high (Figure 20).

Figure 20: Retail Cap Rates by Region

Source: BLS, CBRE Research Q2 2023.

Figure 21: Global Office Rent Index (Q1 2001 = 100)

Weighted average of Class A office in top markets for each region, end of period quarterly.
Source: Source: CBRE Research, Q4 2022.

On the occupier front, nominal Class A office rents are holding up well despite a notable drop in overall leasing activity in the U.S. and Europe in Q1. Class A rent stability reflects both flight-to-quality demand and an increase in landlord offerings of rent-free periods and tenant improvement allowances (Figure 21). Office attendance in Europe has risen above 70% in recent months. This has pushed up prime office rents, which along with the rise in yields (Figure 18) makes Europe office assets one of the more attractive investments on offer at present. Asia-Pacific continues to see strong flight-to-quality demand but the substantial supply pipeline is dragging on rents.

The overall U.S. office vacancy rate is at a record high as the office attendance rate lags that of Asia-Pacific and Europe (Figure 22). Long commutes from the suburbs, big-city crime, tech sector layoffs and a possible recession will keep leasing weak over the remainder of 2023, with demand unlikely to grow until 2024. Sentiment about the U.S. office sector is extremely negative right now, but our view is that as economic growth resumes, the gap between office employment and office attendance rates will start to close (Figure 23).

Figure 22: U.S. Office Vacancy Rate (%)

Source: CBRE EA, CBRE Research Q1 2023

Figure 23: U.S. Office-Using Employment & Occupied Office Space Index (Q1 2008=100)

Source: CBRE Research, Q1 2023.

Although global industrial rents continue to grow amid low vacancy levels, demand is slowing due to worries about an impending U.S. recession. Rent growth likely will ease as global economic growth slows, with demand set to weaken further as retailers and other users of industrial & logistics space cut inventory.

Figure 24: Industrial Rent Index (Q1 2003 = 100)

Weighted average of Class A industrial in top markets for each region, end of period quarterly.
Source: CBRE Research, Q4 2022.

An increase in U.S. industrial real estate supply over the next several months will limit rent growth (Figure 25). European industrial markets will be comparatively well protected from any economic downturn as the region’s supply pipeline is significantly smaller (Figure 26).

Figure 25: Key U.S. Industrial Fundamentals

Source: CBRE EA, CBRE Research Q1 2023.

Figure 26: Europe Existing & Under-Construction Industrial Supply

Source: CBRE Q2 2023.

Asia-Pacific industrial markets generally have tighter vacancy and significantly higher rents and tighter spreads, making them attractive to investors (Figure 27).

Figure 27: Forecast Net-Effective Rent Growth for Prime Asia-Pacific Industrial Space vs. Yield Spread with 10-Year Bonds

Source: CBRE Research, February 2023.
Notes: Vacancy is the latest available data for each market and is represented by the size of the bubble within the graph. Spread represents the risk premium, which is the difference between property yields and 10-year government bond yields Color of bubble represents country.

The U.S. multifamily sector has seen strong demand over the past 10 years but soon will see net absorption fall below completions (Figure 28). Although this will cause a sharp decline in rent growth, it will support the sector’s long-term health. Household economics continue to favor multifamily, with high mortgage rates further pushing people into rental housing (Figure 29).

Figure 28: Key U.S. Multifamily Fundamentals

Source: CBRE Econometric Advisors, CBRE Research Q1 2023.

Figure 29: U.S. Average Monthly Mortgage Payment vs. Monthly Rent

Source: CBRE Research, CBRE Econometric Advisors, National Association of Realtors, Freddie Mac, December 2022.

Multifamily also continues to perform well in Europe, backed by low supply and a far smaller construction pipeline relative to the U.S. (Figure 30). The high price of mortgages relative to rents is also underpinning demand, ensuring the sector remains an attractive investment target (Figure 31).

Figure 30: European Development Activity Not Enough to Meet Demand

Source: Eurostat, January 2023.

Figure 31: Monthly Mortgage Payments vs. Rent for 60-sq.-m. Apartment in Select European Cities*

Source: CBRE Research; National Statistics Agencies; OECD; European Central Bank; Numbeo, January 2023.
*: Amsterdam, Barcelona, Berlin, Cologne, Copenhagen, Dublin, Dusseldorf, Frankfurt, Gothenburg, Hamburg, Helsinki, Lyon, Madrid, Malmo, Munich, Paris, Rotterdam, Stockholm, Stuttgart, Vienna, Warsaw.

Retail has been the surprise sector in 2023, thanks to resilient consumer spending (Figure 32). Rents are rising in the U.S. and Europe, while China’s reopening is set to aid the recovery in Asia-Pacific. Very little new retail development in the U.S. has caused an increase in retail sales per sq. ft. in recent years, with anecdotal reports suggesting that retailer expansions are being hampered by a lack of high-quality space (Figure 33).

Figure 32: Global Retail Rent Index (Q1 2003 = 100)

Weighted average of Class A retail in top markets for each region, end of period quarterly.
Source: Eurostat, January 2023.

Figure 33: Key U.S. Retail Fundamentals

Source: CBRE Econometric Advisors, CBRE Research, Q1 2023.

Through restructuring and the adoption of omnichannel formats, most U.S. retailers are in good shape to withstand an economic recession later this year. Leasing activity should remain relatively strong, driven by online retailers taking brick-and-mortar space. Good yields and solid fundamentals will ensure the sector remains attractive to investors.

Other retail trends include landlords with older but well-located retail assets adding in residential components—a strategy that has been successful in the U.S. and Europe.

The Asia-Pacific retail sector remains healthy. Most retailers expect to add new stores this year, with China’s consumer-based recovery set to provide additional tailwinds to growth (Figures 34 & 35).

Figure 34: Plans for Physical Store Networks in Asia-Pacific in 2023

Note: Figures may not add up to 100% due to rounding issues.
Source: 2023 Asia Pacific Retail Flash Survey, CBRE Research, January 2023.

Figure 35: Where Retailers Plan to Open New Stores in Asia-Pacific in 2023

Note: Figures may not add up to 100% due to rounding issues.
Source: 2023 Asia Pacific Retail Flash Survey, CBRE Research, January 2023.

Forecasts for the next 12 months are highly uncertain. Expectations range from a neither-too-hot-nor-too-cold “Goldilocks Economy,” with inflation falling and the economy slowing but avoiding a recession, to a severe recession precipitated by collapsing commercial real estate prices.

CBRE’s view is between these two extremes. High interest rates through the end of 2023 should put core inflation on a downward path. Tight monetary policy will push the U.S. into a technical recession, with unemployment rising to 4.9%, but there won’t be a major economic contraction like in 2008-2009. Europe will escape a recession but will have very subdued economic growth. Asia will be buoyed by economic recovery in China.

Fundamentals are in reasonable shape, but all real estate sectors will see a period of weak demand and elevated supply that will erode rent growth. Office will fare the worst, particularly in the U.S. where post-pandemic space utilization levels remain around 50%. The Asian office sector also will be impacted by high levels of new supply. The hotel sector should fare a little better because of demographics and pent-up travel demand.

The main issue for real estate is the higher cost and reduced availability of debt capital. Values have already fallen and will be further pressured by a wave of maturing loans that were underwritten five years ago. Some of these loans will be extended but others will default.

Our view is that the banking system is not under threat as in the Global Financial Crisis, but substantial losses will inhibit capital markets activity and value recovery. Market distress will also be an opportunity for $400 billion of uncommitted capital.

Notwithstanding financial stress in the real estate sector, we believe this may be the most benign end to an economic cycle in 40 years. For that, we can thank the changes to the economy wrought by the pandemic and the low-growth, low-inflation period of 2009 to 2019 that prevented the buildup of leverage in the consumer and business sectors. Relative to previous recessions, private-sector financial balances are in good shape, which is why the expected recession will be moderate and relatively short.