Stagflation’s Potential Impact on CRE Investing
Stagflation is characterized by an economic period of:
High inflation
Low economic output
High unemployment
Rising prices in prices in tandem with low employment and economic output is truly a worst-case scenario.
As of Q2 2024, the U.S. economy is far from stagflation territory. However, sticky inflation and a tepid Q1 GDP report may have real estate investors on high alert.
I plan to discuss the components of stagflation, the last time the U.S. faced it, track and asses the vital stagflation indicators, and brainstorm how an episode may impact multifamily investing.
Contents
1970s Stagflation
The last period of stagflation took place in the 1970s, specifically from 1973 to 1982. An oil embargo that led to soaring energy costs reverberated through the economy and caused significant price hikes for American consumers. Three recessions took place during this period:
Q4 1973 - Q1 1975
Q2 1979 - Q3 1980
Q2 1981 - Q3 1983
Between 1975 and 1979 (recessions #1 and #2), inflation and unemployment remained elevated above historical norms.
Inflation had multiple double-digit years, reaching 13.5% in 1980 (minneapolisfed.org).
Unemployment (monthly) reached as high as 9% in 1975 and spiked again to 10.8% in 1982 (stlouisfed.org).
GDP growth was negative for four years during the decade and bottomed at -1.82% in 1982 (stlouisfed.org).
Ultimately, a fed funds rate of nearly 20% (the Volcker shock, see image below), an oil glut, and fiscal reform finally curbed the lingering stagflation in the early 80s.
Source: stlouisfed.org
Stagflation Risk Post-Pandemic
Since the pandemic, it's been a battle to reign in inflation. While the Fed has aggressively raised rates and cut its balance sheet (quantitative tightening) over the past few years, the employment market has remained resilient. GDP has surprised on the upside multiple quarters, and only recently have cracks started to show.
To date, here is how GPD, inflation, and unemployment have been tracked since 2021:
While the current numbers are far from stagflation risk, the recent GDP reading of 1.6% was a big disappointment. Year-over-year inflation has been around 3%, well above the Fed's 2% mandate. Unemployment is still near historic lows.
It will be interesting to track the current trends against the 1970s data:
Thankfully, inflation and unemployment are in relatively good shape and GDP is still positive, but pressure on the economy is mounting.
CRE Returns During Stagflation
It was challenging to find data about how commercial real estate was affected during the 1970s and 1980s, other than anecdotal statements of CRE performing better than other asset classes like stocks and bonds.
The best historical CRE indicator I could find was NAREIT's FTSE All Equity REIT Index. Per FTSE RUSSELL (opens as a PDF), today's subsector breakdown is the following:
Apartments 9.24%
Data Centers 9.53%
Diversified 1.83%
Free Standing 5.36%
Gaming REITs 3.37%
Health Care 8.76%
Industrial 13.62%
Lodging/Resorts 3.08%
Manufactured Homes 2.23%
Office 5.01%
Regional Malls 4.35%
Self-Storage 7.05%
Shopping Centers 5.01%
Single Family Homes 2.69%
Specialty 3.25%
Telecommunications REITs 12.85%
Timberland REITs 2.76%
A diversified mix of asset classes is included in the index.
There has been tracking since 1971, and while the composition is undoubtedly different today than 50 years ago, it still provides a valuable history of real estate performance during turbulent economic hardships.
From 1972-1982, the index moved from 108.01 to 371.49.
A 13.15% annualized return.
The REIT basket boasted about a +4.44% clearance over inflation during that period.
S&P 500 During Stagflation
How did stocks perform over this period?
I used the S&P 500 calculation provided by dqydj.com. The S&P 500 gained only 1.7% annually from December 1972 to December 1982, well below the inflation rate. This return doesn't include dividend reinvestment, which would have impacted total returns materially over a decade. Including dividend reinvestment, the returns jumped to 6.5% annually, improved but still below the inflation rate.
REIT Performance Today
Appropriately leveraged real estate with long-term debt could outperform inflation even if unemployment spikes and GDP dips negative for a few years.
Many publicly traded REITs have already suffered during the past two years as the Fed has aggressively raised interest rates. Many REIT companies are down 30% - 45% from all-time highs and are currently trading below their NAVs.
Interestingly, the REIT index was down 33% from 1971 to 1974 but appreciated annually through 1982.
Could a similar rally be in the cards in the 2020 decade?
Stagflation Impact on Multifamily Investing
Here are a few ways multifamily investing could be impacted during prolonged stagflation.
Continued Transaction Scarcity
Properties would sell only in instances of distress. Owners will be motivated to hold assets with satisfactory financing terms instead of selling and competing for another property in a high-interest rate environment. It will also be challenging to embark on development projects.
Increased Rent Demand
Rents could be stable, or upside pressure could even be seen as home costs continue to rise, making renting by necessity a more prominent theme than it already is. The choppy capital markets and economic uncertainty will sideline potential development projects, helping eat into the current apartment supply glut and putting more upside pressure on rents.
Winners & Losers by Location
Specific industries will struggle more than others in a stagflation environment. Therefore, multifamily investments in submarkets depending on employment centers like manufacturing, travel/hospitality, and energy may see a population decline, less renter demand, and, ultimately, asset declines.
Inconsistent Operations
Inflation could further wreak havoc on various expenses, similar to how insurance, payroll, and labor have been affected since the pandemic. The revenue side may also have high bad debt as residents deal with unemployment, pay cuts, and inflation impacting their fixed expenses. It could be incredibly challenging to budget and hit proforma projections.
Summarizing the Stagflation Threat
While inflation seems stuck well above the Fed's mandate, and the GPD reading is trending negatively, employment in the U.S. has been incredibly resilient against the Fed's hawkish monetary policy. If the employment trend reverses in the upcoming quarters and unemployment starts to spike, the stagflation risk could become more serious.
Looking back at the data, commercial real estate was relatively strong during the stagflation era of the 1970s. Data tells us CRE has a good chance of outperforming the stock market, especially with real estate valuations already down significantly in many U.S. markets.
However, there will be challenges and unknowns that commercial real estate investing operators would need to grapple with; in the multifamily sector, this could include:
Transaction/development scarcity
Uncertain rental projections
Location more prone to poor economic fundamentals
Inconsistent operations
With prudent projection and execution, sound real estate investment should prevail regardless of the macro.
