The repercussions of inflation, Fed rate hikes, the ongoing banking crisis, and the approaching debt ceiling deadline are cascading throughout the financial system. One area directly impacted by these shocks is real estate across both the residential and commercial sectors. Commercial real estate (CRE), in particular, is highly dependent on regional and smaller banks, including those that have struggled or failed since early March. Some investors and economists are concerned about what this might mean for the broader economy in the coming months.
We discuss in this episode of The Wealth Effect Podcast:
🏢 Commercial Real Estate Performance
🏡 Residential Real Estate Performance
🏦 Fed Rate Hike Cycle
Matt Faubion, CFP®
Founder - Wealth Manager
Show notes and charts:
Commercial real estate has struggled the past year
According to the recently released Financial Stability Report by the Federal Reserve, smaller banks (those with $100 billion in assets or less) hold more than two-thirds of CRE loans by dollar value, totaling nearly $1.6 trillion. When midsize and regional banks are included, this proportion jumps to 87%. Similarly, the Fed's latest Senior Loan Officer Opinion Survey suggests that both the demand and credit conditions for CRE and industrial loans have tightened. From a microeconomic perspective, these data show that the CRE industry may continue to face challenging times ahead, and projects will depend heavily on the ability to secure financing, the quality of banking relationships, and the specific economic sector we are looking at.
Housing prices have fallen from their recent peaks
The housing market affects the economy and financial markets in significant ways. As individuals, primary residences are usually the most valuable assets on household balance sheets, and monthly mortgage payments are the largest expenses. As diversified investors, the housing market can represent an income-generating asset class in addition to a macroeconomic indicator. Rising home prices can bolster financial confidence and spur consumer spending, and vice versa, i.e., the "wealth effect."
Fed policy rates are far above market rates
Despite these historic challenges across commercial and residential real estate, few investors expect a repeat of the 2008 crisis driven by a bubble in residential housing and significant financial leverage. Although, as one of the most successful long-term investors, Stanley Druckenmiller, noted in a recent interview, it would be naive to assume that something similar is not a possible outcome provided the current macroeconomic condition set.
So, it's unsurprising that this would create instability in some parts of the economy, especially in interest rate-sensitive areas such as real estate. After all, the Fed has a dual mandate: price stability (i.e., inflation) and full employment. Currently, with the unemployment rate standing at near-historic lows of 3.4%, The Fed has general employment in spades. However, with inflation of 4.9%, The Fed remains 2.5x off of its goal of 2% inflation.
The bottom line: While there are challenges in areas such as banking and commercial real estate, The Fed remains in inflation-fighting mode, which will likely perpetuate this period of monetary, financial, and economic instability.
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