2003 Economic Outlook: Calm Waters Ahead

Continuing low interest rates and modest growth in the economy will keep home sales on a strong footing and give commercial activity a boost in 2003, practitioners and analysts say.

Interest rates next year are expected to hover in the 6.2 percent to 6.8 percent range, up about a percentage point from the 40-year low they had reached briefly in late 2002.

The projected rates are low enough to keep money flowing into home sales but at a pace more sustainable than the record rate in 2002. Sales of both existing and new homes hit all-time highs this year—roughly 5.5 million and 930,000 units, respectively—despite the sluggishness in the broader economy. For 2003, sales are expected to hit 5.3 million for existing homes and 900,000 for new homes.

“To a great extent, continuing low interest rates will offset the effects of uncertainty over the economy,” says NAR Chief Economist David Lereah.

Commercial transactions were far more constrained this year, dampened by flat business spending. But even in 2002, trend lines were beginning to point upward from levels in 2001 and early 2002, thanks in part to small and mid-sized companies looking to take advantage of low rates to own their own real estate. Data tracked by the CCIM Institute and the Landauer Realty Group show the number of commercial sales transactions jumping in the second quarter of 2002, from about 580 in the first quarter to 680 transactions. Total volume was almost $14 billion for the quarter, with all sectors—office, retail, warehouse, hotel, and multifamily showing solid volume.

“The entrepreneurial middle-market user is more interested in owning now than leasing, based on capital structures [low interest rates],” says Garry Weiss, CCIM, SIOR, senior vice president and national director of Integrated Industrial Solutions, a division of First Industrial Realty Trust in Chicago.

As they did this year, residential and commercial property markets are expected to benefit in 2003 from continuing poor equity yields in the stock market. With key stock indexes struggling against steep price declines, consumers and investors will keep looking to real estate as solid, well-grounded assets with stable price growth. That will keep capital flowing into real estate even as interest rates tick up.

At the same time, neither the residential nor the commercial markets are unlikely to see major price swings down, maintaining the attraction of real estate as a stable asset class. That’s because the price growth is well-anchored in strong demand and tight supply.

Residential inventories were seen softening in the latter part of 2002—with the sales backlog increasing from 4.2 months at the beginning of the year to about 5 months in August—but not enough to suggest a major dampening in demand. Indeed, the softening is expected to help cool price increases and further stabilize the market as supply and demand come into a balance.

Look for average home price appreciation of 4 percent in 2003, in line with historical levels and down from about 6.8 percent in 2002.

The relatively stable price picture and its well-grounded foundation in the supply and demand equation makes a strong case against some scattered views by analysts that housing is following the stock market into a speculative bubble.

“Plain and simple, people are buying homes to live in, not to speculate with,” says Lereah. The picture is similar on the commercial side. After peaking in mid-2001 to about $31 million then dropping to $15 million at the start of 2002, the average sale price for all sectors has stabilized at roughly $20 million, which puts prices in line with levels in 2000, right before prices started spiking. “The data seem to suggest that the market is back on stride after coping with a very difficult second half of 2001,” says the CCIM Institute/Landauer Realty Group report.

As in the residential market, inventory constraints have been a key feature of the commercial sector’s stability during the economic slowdown. Unlike in the recession in the early 1990s, when easy capital fueled a speculative building boom, commercial development in all sectors has been kept largely in check, although projects planned years ago are now starting to become available in some markets, pushing down net absorption rates, particularly in the office sector.

But vacancies throughout the sectors have remained manageable, particularly when compared with the early 1990s, when vacancies hovered around 30 percent in hard-hit markets.

In the office sector, look for vacancies to drop to under 15 percent from more than 16 percent at the end of 2002. Similar drops are anticipated in the other sectors. In warehouses, vacancies will drop from above 10 percent to about 8.6 percent; retail from 13 percent to 11.8 percent; and multifamily from 7.1 percent to 6.6 percent.

For both residential and commercial markets, including commercial leasing transactions, job creation holds the key to business in the mid- to long-term, and on that front the signs are fairly positive. Unemployment is expected to ease to between 5.4 and 5.7 percent throughout 2003 compared with about 6 percent in mid-2002. The strengthened employment picture will help drive the higher interest rates, which could slow sales, but it will increase economic stability and lay the foundation for solid performance in all property sectors for the year. Overall, prospects remain surprisingly strong for real estate in 2003.

Commercial Sectors: Holding up

The economic slowdown that began about two years ago has cooled sales and driven up vacancies in the office, warehouse, retail, and multifamily sectors, but 2003 could mark the start of a turnaround for all the sectors. Here’s a brief look at them.

Office. Net absorption of office space is expected to rise in the second half of 2003, fueled by modest job growth and an easing of new development. Still, with a surplus of space to be filled, landlords will rely on incentives to attract tenants, which will keep rent growth trending downward. Hot market: One of the tightest in 2002, the Washington, D.C., office market is expected to benefit from continued good job growth.

Warehouse. Business investment is expected to increase as suppliers, having let inventories run down in 2002, rebuild stocks. At the same time, newly available space will taper off, leading to healthy absorption levels. Higher occupancy will bolster landlords as they increase rent levels. Hot market: The occupancy leader in the first half of 2002, Palm Beach County, Fla., should stay at the top of markets as it benefits from healthy employment growth and controlled development.

Retail. Consumer spending is expected to hold up, as consumers continue to take advantage of low inflation and tap equity through refinancings. Against fewer deliveries of new space, net absorption is projected to soar to three times 2002 levels, improving occupancy rates. Hot market: One of the tops in occupancy, the East Bay, Calif., metro area should post a rebound in line with other top performers.

Multifamily. Modest job growth that encourages household formation, coupled with tempered new development and softening home sales, will spur an uptick in rental occupancies. Hot market: A low-vacancy leader this year, Minneapolis will continue to enjoy favorable supply-demand fundamentals.

Editor’s Note: A reference to this outlook in the December 2002 issue of REALTOR® Magazine (page 18) was based on a mid-October forecast by the NATIONAL ASSOCIATION OF REALTORS® Research Department. Since that time, NAR has adjusted its 2003 forecast, most notably its forecast for interest rates. NAR economists now say rates for 30-year fixed-rate mortgages won’t break 7 percent during 2003.

GDP growth

Gross domestic product is a U.S. Commerce Dept. measure of the total value of goods and services produced and consumed in the U.S. economy.

Consumer confidence

This Conference Board Index measures consumers' attitudes toward the economy, the local job market, and their own financial condition. (Base level of 100 was set in 1985.)

Unemployment rate

This U.S. Bureau of Labor statistic measures the percentage of Americans actively seeking work.

Source: NAR Research forecast as of Nov. 13, based on Macroeconomic Advisors quarterly model of the U.S. economy.

Residential performance indicators: Housing sales* (in thousands)

Existing single-family

New single-family

*Numbers represent the seasonally adjusted annual rate, which is the actual rate of sales for the quarter, multiplied by four, and adjusted for seasonal sales differences.

Mortgage rates: 30-year fixed

Mortgage rates: 1-year adjustable

Median home price (in thousands): Existing single-family

Median home price (in thousands): New single-family

Source: NAR Research forecast as of Nov. 13, based on Macroeconomic Advisors quarterly model of the U.S. economy.

Commercial performance indicators

Vacancy rates: Office

Vacancy rates: Retail

Vacancy rates: Warehouse

Vacancy rates: Multifamily

Commercial starts (square feet in millions): Office

Commercial starts (square feet in millions): Retail

Commercial starts (square feet in millions): Warehouse

Commercial starts (units in thousands): Multifamily

Source: NAR Research, Property and Portfolio Research.