Will Commercial Real Estate Feel the Pinch of the Fiscal Cliff?

By Anna Spiewak, News Editor: Cassidy Turley forecasts three possible outcomes for the economy and the commercial real estate market, depending on how the government deals with the fiscal cliff. Find out which one is most likely.

Kevin Thorpe, chief economist, principal at Cassidy Turley

Since the Super-committee has failed to reach a bipartisan agreement on fiscal policies, sequestration cuts are scheduled to take place come Jan. 2. As buyers and sellers stand on opposite sides of the ring, waiting to see what happens with the economy next year, Cassidy Turley is hopeful about the future of the nation’s economics.

The commercial real estate firm predicts three possible outcomes relating to the “fiscal cliff,” the phrase coined by Fed Chairman Ben Bernanke in reference to the impact of the budget sequestration and tax increases on the U.S. economy, causing a new recession all over again. (“Budget sequestration” is a law procedure reducing the budget by $984 billion over the next 10 years, with half of the cuts going toward defense and the other half going to non-defense programs.)

“No one really expects the cliff to occur, and yet everyone seems to be treading water, in total wait-and-see mode,” Kevin Thorpe, chief economist & principal at Cassidy Turley, told CPE.

Toronto-based research group Capital Economics places the chance of the fiscal cliff actually taking place at 30 percent. The odds are low because most surmise that both parties would rather work out a solution than be the cause of a new recession.

Source: Moody’s

If the fiscal cliff does occur, though, Cassidy Turley estimates that U.S. office space would register 2.6 million square feet of negative absorption in 2013. Office vacancy rates would rise by 10 basis points, since lack of new supply would prevent a spike, and rents would move sideways at near bottom levels. The sole good outcome of this dynamic would be a decrease in the deficit of fiscal year 2013.

In the second scenario, the cliff does not take place but neither does any fiscal restraint. There is a 20 percent probability of this occurring, and it represents the worst scenario for the “long-term health of the commercial real estate markets.” Market confidence would improve, leading to an increase in the pace of hiring, consumption and investment, as well as an increase in net demand for office space. But ignoring the deficit is not a sustainable solution.

The third and most likely scenario, with a 50 percent probability of occurring, is the hybrid, which Moody’s Investors Service terms the “Fiscal Nirvana.” The fiscal cliff is smaller and more manageable due to the introduction of needed policy adjustments to achieve long-term fiscal sustainability. The hybrid scenario combines the extension of some entitlement and tax reform, in addition to smaller cuts in federal spending. Under this prediction, given upcoming spending cuts and tax increases, the commercial real estate metric are expected to weaken over the first half of 2013 and to rebound in the second half of the year. U.S. office sector absorption will be slightly below the historical average, though enough to make progress towards stable recovery.

“There is no visibility into how the federal government will address the deficit, taxes, spending cuts and entitlements,” said Thorpe. “The U.S. economy has virtually no chance of growing at its full potential until policymakers address all of these key issues. This is one of the primary reasons the U.S. economy is currently going through what I call a big fat pause.”

Nevertheless, Cassidy Turley forecasts scenario three taking place. “It feels like a leap of faith at times, but I am optimistic that policymakers will come together and give the market a clear vision for the future,” Thorpe added. “If we get that, then I believe the U.S. economy will strengthen, as will CRE fundamentals.”