March 3, 2020

Executive Summary

  • The Fed cut short-term interest rates by 50 bps to a target range of 1.0% to 1.25% in response to increasing economic risks from the worldwide coronavirus outbreak (COVID-19).
  • G7 finance ministers affirmed “commitment to use all appropriate policy tools” in response to evolving threats to economic growth but did not announce a definitive plan of action.
  • Near-term risks to the economy are to the downside, but there is upside potential in the longer term.

Why the Fed Moved

In an emergency meeting today, the Federal Reserve cut the federal funds rate by 50 bps to a target range of 1.0% to 1.25%. The last time rates were this low was in June 2017 and the last time rates were cut by 50 bps in one move was at the height of the financial crisis in 2008.

The markets are pricing an additional 50 bps in cuts before the end of the year. The Fed’s changing policy stance is a response to increased threats to the economy from the evolving COVID-19 outbreak. Fed Chairman Jerome Powell cited challenges for the travel industry and industries with global supply chains but noted that the extent of impact remains highly uncertain.

Monetary policy alone will not be enough to mute negative economic impacts from COVID-19. Additional policy responses—particularly from fiscal authorities—will be needed. To that end, the G7 finance ministers affirmed their “commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.” While G7 leaders did not announce any definitive plan of action, they have additional capacity to mitigate risks to the economy posed by the spread of COVID-19. At the outside, the lifting of trade tariffs is a possibility.

Implications for Commercial Real Estate

Commercial real estate fundamentals entered this crisis in an extremely strong position. Moreover, labor markets are very tight, and companies likely will maintain their employment levels through the crisis. Nevertheless, property markets will reflect the broader economy, which is expected to see a short-term slowdown. Should the spread of the virus prove to be only seasonal, impacts will lessen as the weather warms, allowing for stronger growth in the second half of the year.

Capital markets transactions likely will slow for the time being, but capital values should be resilient. Additionally, there may be some impact on leasing, as decisions on new space are deferred until later in the year. With the 10-year Treasury trading at historically low levels—below 1% for the first time—low interest rates will be a positive factor for property markets.

Hotels: There has been a reduction in business and leisure travel, both globally and domestically. Using the SARS pandemic of 2003 as an example, the hotel industry could be severely impacted for up to six months.

Retail: Near-term impacts will occur due to reductions in travel, particularly for food & beverage establishments, entertainment venues and fashion retailers. Omnichannel retailers could see some near-term upside as consumers avoid stores and shopping malls, but consumer sentiment may weigh on the sector over a longer period.

Industrial: Manufacturing and distribution facilities may be impacted by lack of inventory as supply chains are disrupted. Broader economic impacts could further weigh on the industrial sector as reductions in both supply and demand ripple across the economy. Conversely, if the virus prompts more people to shop for goods and food online, this would bolster demand for last-mile distribution space.

Office and Multifamily: Impacts on fundamentals in these sectors likely will be secondary and more closely associated with overall economic activity.

Construction: Building material supply chains are being affected with significant backlogs at Chinese ports. Imports from other parts of Asia are also being impacted. Multifamily construction likely will feel the most acute effects due the importance of Asian-sourced materials for residential construction.

Bottom Line

Property market fundamentals are well-positioned heading into a period of economic uncertainty but still will be affected. Downside risks have increased as COVID-19 spreads worldwide. Market volatility is a threat to the consumer confidence that has underpinned economic growth over the past year. A deterioration in consumer sentiment may further affect the outlook.

It is unlikely that confidence will return until the spread of COVID-19 is contained, which is why the Fed acted urgently today. Furthermore, fiscal and monetary policymakers retain significant capacity to act forcefully in response to additional downside risks posed by this evolving threat to economic activity. In the long term, pent-up demand and the lagged effects of monetary policy should provide significant tailwinds to the global economy.

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