As appeared in the Dallas Business Journal
One word sums up the current state of commercial real estate: Uncertainty.
That uncertainty is connected to issues like higher-for-longer interest rates and economic ambiguity. Will there be a recession? What will happen with inflation? Will the Fed REALLY cut rates this year? And so on.
As a result, making economic predictions (and, by extension, determining CRE’s next steps) has been a challenge. The latest crystal ball effort comes from KKR, which predicts three Effective Federal Rate Funds cuts (totaling 75 basis points) by the end of the year and a near-term 10-year Treasury yield of 3.75%. The write-up also forecasts a rolling recession versus an economic hard landing.
Understanding KKR’s belief in a rolling recession can clarify the North Texas commercial real estate sector analysis.
Unraveling the Rolling Recession
A rolling recession isn’t as drastic as a total economic downturn. Rather than impacting the entire economy, a rolling recession involves a decline in certain sectors while leaving others unscathed. As one area recovers, the slowdown “rolls” into another one.
According to KKR, here are areas impacted by the recent rolling recession:
- Construction growth lag (2022)
- Supply chain slowdowns and inventory corrections (2023)
- Consumer discretionary spending slowdown (2024)
KKR’s investment advice centers on low risk. Specifically, the experts suggested paying attention to “more non-correlated assets, especially ones backed by collateral and/or with operational upside, makes a lot of sense.”
Like commercial real estate.
It’s true that the above-mentioned uncertainties have kept investors on the sideline, while traditional lenders have pulled back. But private lenders—like Revere Capital—have provided necessary capital to borrowers who find the right commercial real estate opportunities.
DFW: Robust Economy? Or Slow Downturn?
Before plunging into a discussion about the DFW CRE sector, it’s a good idea to understand what’s happening to the North Texas economy. The Bureau of Labor Statistics reported that Dallas-Fort Worth’s preliminary unemployment rate in June 2024 stood at 4.3%, an increase from May’s 3.6%. Meanwhile, preliminary job growth in July 2024 was 1.3% year over year, down from 1.5% in June 2024.
At the same time, DFW’s Consumer Price Index for All Urban Consumers (CPI-U) fell 0.6% for two months ending in July 2024. Still, the metric showed an annual increase of 4.1%.
Basically, DFW faces slowing job growth with an increase in unemployment and prices. This plays into KKR’s concerns about consumer spending. As fewer people are employed and prices continue escalating, spending declines. That decline could impact Dallas-Fort Worth CRE in the following ways.
Retail: VERY Dependent on Consumer Spending
During the early 2000s, the glut of North Texas retail space outstripped demand. Also in play was the “Amazon effect,” in which more people bought goods online rather than from brick-and-mortar stores.
The retail tide turned in the aftermath of the pandemic. Partners Real Estate reported that as of Q2 2024, the retail sector had experienced 15 consecutive quarters of positive net absorption, while vacancy was 4.8%. The “Amazon effect” declines as more shoppers seek an on-site experience. Then there’s the dwindling construction pipeline, meaning less available space.
The primary beneficiaries of the current scenario are neighborhood strip centers and grocery-anchored properties. But the bug in this ointment is a potential falloff in consumer spending. Though retail continues to be a real estate darling, economic factors must be watched.
Industrial: Partners with Retail, Plus Supply Chain issues
In recent years, North Texas experienced an industrial construction boom. Developers attempted to keep up with pandemic and post-pandemic demand by delivering spec space for logistics and storage. Today, demand is down, while much space remains to be absorbed. Partners Real Estate reported a Q2 2024 vacancy of 9.7% (well above the previous sub-5% figure).
Industrial, like retail, has been a bright spot for real estate. However, the sector’s future is also tied to consumer spending. Less spending means less inventory. Less inventory means less need for warehouse or logistics space. Then there are supply chain issues, like geopolitical challenges (think tariffs and trade) and climate-change-related weather hazards (think hurricanes and wildfires).
Multifamily: Supply Outstrips Demand
Like the industrial sector, North Texas’s multifamily supply has experienced a boost over the past two years. According to recent numbers from Colliers, 64,120 units are under construction throughout DFW, with 41,484 units scheduled for delivery within the next year. Yet supply is outpacing demand.
However, here’s why DFW multifamily should do well, even with a supply glut:
- People keep moving here. According to the U.S. Census Bureau, over 150,000 people moved to North Texas in 2023.
- Buying is more expensive than renting. A March 2024 report from CBRE said it costs 115% more to buy a home than to rent an apartment (or home) in Dallas. This is due to higher mortgage rates, increased insurance costs and home goods price hikes.
While not directly connected with a potential consumer spending downturn, North Texas apartments can be considered another bright spot for investment, thanks to the fundamentals.
Office: Poor Performance, Interesting Opportunities
Out of the four main CRE “food groups,” office continues to struggle. The challenges have nothing to do with consumer spending and everything to do with adaptation to the new normal of hybrid work. Q2 figures from Partners Real Estate showed a 25.6% vacancy and negative net absorption, even as 4.8 million square feet are under construction.
Still, there are office space prospects. Conversions are a hot topic; an office building that can be re-adapted for another use without much capital expenditure can be a good investment. Office properties offering a solid per-square-foot basis and opportunistic potential can also work.
Geography plays a role, too. Downtown Dallas properties are struggling. However, it’s possible to find diamonds in the rough in other submarkets.
Economic Fundamentals and DFW CRE
Gazing through KKR’s crystal ball, the U.S. economy will likely avoid a hard landing. But it’s essential to consider rolling recessions and their impact on commercial real estate.
From a local perspective, the Dallas-Fort Worth economy is considered robust. Along those lines, Revere Capital has closed multiple multifamily, land, hospitality and office deals throughout DFW, underscoring available opportunities with CRE investments.
Still, a consumer spending downturn due to slower job growth and higher prices can’t be ruled out. These and other factors can influence commercial real estate performance. As such, investment in retail, industrial, multifamily and office space requires an in-depth economic analysis, along with due diligence and market research.