“If you strip out the cost of energy and food, the picture is a bit more promising.”
Last week’s inflation numbers, which clocked in at 9.1%, will “certainly” impact interest rates which potentially increases recession risk—and it could also affect the flow of capital to different property types in different parts of the US.
That’s according to Marcus & Millichap’s John Chang, who notes that headline CPI inflation reached its highest level in 41 years, thanks in large part to energy prices,
“But if you strip out the cost of energy and food, just looking at core inflation, the picture is a bit more promising,” Chang says. Core inflation was only 5.9%, and that’s down 60- basis points from its peak in March. And “that tells me a lot,” Chang says.
To wit: most of the inflation lift is in the energy sector, while many commodity prices have been coming down—including lumber, which is down 49% from January, and steel, which is down 41% since March. The cost of shipping a container from China has fallen to $7,000 from a peak above $20,000 in September (but still five times pre-pandemic levels). And gas prices are also declining.
“It looks like the inflationary pressures may be leveling off, but we’re not in the clear yet,” Chang says. The war in Ukraine will almost certainly continue to impact oil and food prices, he says, and even if inflation does level off, it still remains high and will force the Fed to take additional measures via future rate hikes.
Chang says “blinking recession indicators are spooking Wall Street,” putting downward pressure on the stock market and in turn driving long term interest rates. And the yield in the two-year Treasury has risen above the 10-year Treasury yield, sparking the inversion that is “commonly recognized as a sign of an impending recession,” he says. But he also notes that the three-month Treasury is a better indicator than the 10-year, and that spread has not yet inverted.
“Remember, a yield curve inversion is not a bulletproof indicator that a recession is coming,” he says.
The takeaways for CRE investors are five-fold, Chang says. Capital is moving to less volatile assets, like CRE, and balance sheet lenders like banks and credit unions may offer lower rates than credit market lenders like CMBS. Chang also says the most inflation resistant property types—like hotels, apartments, and self-storage—remain in favor, while capital is also targeting commercial properties that have strong rental upside like suburban office. Finally, he says capital flows are migrating from the regions that were most in demand last year to higher yield secondary and tertiary markets.
“There’s a lot of capital out there looking for the durable inflation resistant returns offered by real estate,” Chang says.