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Fiscal Cliff: Impact Scenarios for the Commercial Real Estate Industry

 

Cassidy Turley released research examining the impending “fiscal cliff’s” impact on commercial real estate markets across the country.

The fiscal cliff refers to the combination of tax increases and spending cuts that will take effect in January 2013, assuming no change to the current law. Economists’ general consensus is that if the fiscal cliff is allowed to occur, the U.S. economy will slide back into recession in the first half of 2013.

Cassidy Turley’s report summarizes the various scenarios related to fiscal policy and then draws the link to commercial real estate.

Cassidy Turley’s research reveals that Metro Phoenix is the 13th most exposed U.S. market to potential fiscal cliff cuts and would relapse into recession in the worst-case scenario, which research projects at a 30% probability.

In fact, 18% of Metro Phoenix’s Gross Metropolitan Product (GMP) is exposed to sequestration cuts, and those potential cuts would lead to 8,300 job losses, 7.5% unemployment and 1.45% GMP growth. Sequestration also would yield 348,000 SF of negative net absorption, 27.3% vacancy and rent declines of 2.5% for Metro Phoenix’s office market.

Cassidy Turley places the most probable scenario, which involves a short-term deal between Congress and the president, at 70%, and that scenario is much more favorable to metro Phoenix – 3.9%% GMP growth, 42,200 new jobs, 1.7 MSF of office net absorption, 24.9% vacancy and unemployment at 7.1% in 2013.

“The Phoenix metro area is well on its way to an accelerating recovery, and will do so exponentially if policymakers come to an agreement,” said Chris Jantz, Vice President Research of Cassidy Turley Arizona. “It’s imperative that Congress and the president resolve this fiscal crisis with a long-term solution, reduce the federal deficit and create an environment where businesses in Phoenix, Arizona and the U.S. can achieve robust, sustainable growth.”

For U.S. commercial real estate markets, especially cities and regions with clusters of federal contractors, going over the fiscal cliff poses dire consequences.

“Going over the fiscal cliff, and continuing to free-fall is an unlikely scenario, but from a real estate perspective, it’s potentially a devastating scenario,” said Kevin Thorpe, Cassidy Turley’s Chief Economist.

“When you examine our study’s details, you quickly realize how damaging the fiscal cliff will be for so many markets across the country. Washington, D.C., has an obvious bulls-eye on its back, but our study finds that the majority of metros – 23 out of the 30 metros tracked – will experience a recession in 2013 if the tax hikes and spending cuts are not scaled back significantly.”

Cassidy Turley’s report finds that the spending cut’s impact on government contractors will have a direct, adverse correlation on commercial real estate and demand for office space. Sequestration in 2013 would result in actual spending cuts, meaning discretionary defense spending and non-defense spending would be reduced by 9% in 2013 from 2012 levels.

According to the study, the top 100 government contractors occupy a total of 208 MSF of office space in the U.S. – equal to the total office inventory of the entire Dallas metro area. Under the sequestration scenario, the top 100 government contractors would potentially shed 18.7 MSF of office space across the U.S. as the government is forced to tighten its belt on various projects.

“Government contractors are a major tenant in many office markets across the country,”  Thorpe said. “Sequestration is essentially an immediate 9% drop in revenues for the government contracting world. Contractors would invariably need to cut staff, which would create numerous holes in many real estate markets.”

According to Cassidy Turley’s Fiscal Cliff report, the most likely scenario assumes that lawmakers will sign a short-term budget resolution in late December that will extend the Bush administration’s tax cuts for most and resume similar federal spending levels for three to four months. A short-term deal will set the framework for a longer-term budget agreement, and even if an agreement is not reached by the end of 2012, Congress may return in January 2013 and change policies retroactively.

The stalemate still leaves Congress and the President to address the debt ceiling limit, but the Treasury will run out of accounting gimmicks in 1Q or 2Q 2013, again forcing the government’s hand to either finally deliver a “grand plan,” slash spending or default on certain debt obligations.

Despite current uncertainty, resolution would propel the U.S. economy and office market in 2013 and 2014 as 2012 closes relatively strongly. Third-quarter GDP was revised upward to 2.7%, and the U.S. economy has created 173,000 net new jobs per month on average since the summer slowdown.

In November, the Conference Board’s Consumer Confidence Index rose to its highest level in five years, and home-price increases delivered similarly, with increases in 100 out of 132 metros tracked.

“There is a positive script buried in here,” Thorpe said. “If lawmakers can work it out, the U.S. economy appears poised to take the recovery the rest of the way. Real GDP of 2.5% for 2013 is attainable, and 3% or 4% in 2014 is not a stretch given the latest trends in the U.S. economy. Against such a backdrop, demand for office space could be 30% to 40% higher than it has been throughout this recovery. We just need policymakers to get it done.”

 

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