Downturn Coming? 10 Factors to Consider

Lately journalists, economists, developers, researchers—you name it—have broached the topic of the “upcoming downturn.” Many lay claims to when they anticipate a downturn (the consensus seems to predict 2018), as well as to what may be the anticipated cause. In their articles or interviews, each tend to identify one factor as the highest contributor to cause the impending downturn. However, in such a global economy where our systems—finance, housing, public needs, politics, social unrest, tech, the environment, and the list goes on—are increasingly interconnected, how can one factor make it or break it?

Instead of honing in on only one primary causation, we turn to a discussion of numerous key components to consider. In a complex system, where various factors can shift in response to a change in another, we place all of these components on the table for discussion. Therefore, we consider these top key factors to watch as they shift over the coming months and years.

Will minor shifts across multiple factors cause sweeping change? Can the collapse of a single factor be buoyed by the stability or growth of others?  How will the relative ups and downs of one or more factors affect the others and the whole?

 

1.     Rising Interest Rates:

There is nowhere to go but up, but quarter after quarter has seen no change. When the inevitable rise does come, will it have a chilling effect on the real estate market, or will it provide some level of confidence that we are moving towards stability?

2.     Foreign Investment:

Foreign capital has flooded the market, often with an investment mantra that accepts much lower (sometimes none at all) returns, reflective of cloudy or corrupt markets abroad. When that foreign capital stops flowing, or slows considerably, will transaction volume similarly slow?

3.     Cap Rates:

Given foreign investment’s lower return expectations, and given historically low cap rates across property types, how much can cap rate compression be relied upon for future appreciation? Like with interest rates, the expectations are that cap rates will rise, but how quickly and to what extent? How much will values suffer across markets and product types?

4.     Urbanization:

Currently 54% of the world’s population lives in urban areas, and the UN projects that number will increase to 66% by the year 2050. With a continuing influx of people, cities will be forced to accommodate infrastructure, housing, transportation, and other public goods and services. Furthermore, urbanization not only attracts talent, but also lower-income individuals in search of jobs and opportunities, putting even more of a burden on cities. Can the systems in place now bear the challenges of growing populations and increased costs?   

5.     Changes in Demographics:

Although much talk revolves around designing urban environments for America’s largest generation—the Millennials—what happens when they grow up? Will their work-live studio in Downtown LA accommodate a partner and their child? There is much prognostication as to this cohort’s changing lifestyles and needs in the coming years. Will suburbs be shunned or will urban vacancies rise? Will an entirely new product type emerge?

6.     Affordability:

The laws of supply and demand are at play in cities across the country. Some cities continue to see erosions of jobs and talent, and their housing values tumble as a result. Others are the beneficiaries of “new economy” jobs and the quality of life factors that come with them. But, cities can’t build enough housing fast enough to counter growing demand with increased supply. At what point do the gulfs between affordability and jobs erode quality of life to such a point so as to render a place unapproachable from a cost perspective?

7.     Transportation:

We are coming to a fork in the road, or the busway, or the rail line, or the bike lane. On the one hand, many cities are promoting alternative transportation options by making public transportation more accessible and improving bicycling and pedestrian infrastructure. On the other hand, the prospect of driverless cars, as early as 2016, could reshape our local economies, infrastructure, and real estate. How much of an impact will autonomous vehicles really have on the built environment? Will alternatives means of transportation counteract population growth enough to prevent congestion on roads and highways from getting worse?

The U.S. and many other countries face economic headwinds from climate change. The redder the color, the more severe the impact. (Burke, Hsiang, & Miguel; Nature, 2015)

The U.S. and many other countries face economic headwinds from climate change. The redder the color, the more severe the impact. (Burke, Hsiang, & Miguel; Nature, 2015)

8.     Climate Change:

Living in drought-ridden California, we very directly feel the ramifications of climate change. The arid climates will face imminent water-shortages, but also natural disasters will become increasingly detrimental. At this point, the government and its citizens likely face either footing the bill for precautionary measures or for clean-up and restoration. Either way, cities will have a significant burden. Will we see increased regulations and fewer development opportunities, thereby driving up costs? Can technology innovate fast enough to mitigate some of the dangers?

9.     Policies:

Anti-development sentiments continue to grow in some places, but housing shortages persist. No-growth policies, project-by-project community votes, quid pro quo approvals, and well-intentioned regulations transformed in to anti-development weapons add to the time and cost to produce more housing. Where is the balance between neighborhood wants and desires and regional growth allowances?

10.  Global Instability:

Political turmoil, social unrest and financial instability in countries throughout the world affect domestic markets by shaking confidence and impacting the international flow of goods and services. Will upheaval on the other side of the globe panic domestic markets?

 

Although impossible to predict with 100 percent certainty what effects any one of these might have on real estate, we are well advised to consider these shifting factors not as isolated components, but rather interconnected systems, as we continue through the current market cycle and the predicted downturn.