RCA Insights

US Recessions Don’t Always Hurt the Same

By on October 10th, 2019

Nearly every day since late summer I have been asked by participants in the commercial real estate industry if a recession is coming and what might cause a downturn. Predicting downturns is a challenge, but if we are heading into one, I think that “blitzscaling” will play a role.

My sense is that industry participants are so concerned about a potential recession because of the severity of the last downturn, which, for some people, is the only one they have experienced in their careers. If – and it is an if – we have a recession in the near term, I do not expect that it will be as severe as the 2008-09 crisis. People need to look at other downturns as a guide.

Recessions are about an imbalance in the economy that must be worked out of the system. Like a knotted muscle, there will be pain as it is worked out, but things work well again once realigned. In a recession driven by the real side of the economy, the knot is one of workers and physical capital (buildings, computers etc) allocated to activities that just are not productive.

This lack of productivity is where the term “blitzscaling” comes into play. An investment thesis popularized in this economic expansion holds that companies should gain scale before they pursue profitability. The argument is that if one is the first mover, profits will follow. (Amazon is a prime example.) When profitability suddenly does matter, pain is going to be felt in the markets where deal activity in the commercial real estate space has been propped up by tech sector investors.

Looking back at previous recessions, the one that is the best parallel to the imbalances at play in the current market may be the 2001 downturn after the internet boom. With profitability off the menu, at some point investors will realize that they are throwing good money after bad with every subsequent funding round. When this realization dawned on investors in 2000-01, job losses were focused on the technology sector, with pullback in other parts of the economy supporting the tech industry.


The performance of commercial real estate then and now may be different. Into 2001, total returns for commercial real estate slowed but never turned negative, according to the NCREIF data. A falling interest rate environment helped boost the capital value of real estate assets even as income was falling because of the growth in sublet space and falling market rents.

Cap rates compressed sharply in the recovery following the 2001 downturn, Real Capital Analytics data shows. Cap rates fell as the 10yr UST dropped in line with the challenges in the real economy and because of the growing investor interest for safe, yielding assets in the commercial real estate world.

During the tech boom, commercial real estate was not sexy without a tech story to fuel investments, and high cap rates were needed to get investors excited about the sector. Yield is sexy today, however, and while investors were running towards these blitzscaled companies in this expansion, they were chasing commercial real estate investments as well. It is unlikely that the 10yr UST could fall much lower than the 1.5% levels seen in October 2019. It is not clear that cap rates could compress in the current environment as they did in the aftermath of the 2001 recession.

At best, if a recession hits the U.S. economy in the next couple of years, commercial real estate will see flat cap rates. Property income will falter, particularly so in those markets fueled by venture capital-funded tech startups in this cycle. Asset values would adjust downward, but not to the extent seen in 2008-09 when lending for the commercial property sector froze.

All recessions are not the same, though there are elements that rhyme between each. The economic pain and stress our industry will face in a recession will be different from any seen in the past. Different, as in not as deep as 2008-09, but also different in terms of how widespread it may be. Commercial real estate investors should be careful to base their assumptions on the forces at play in the current environment. Looking at previous downturns as a guide can be misleading.

The next edition of US Capital Trends with volume and pricing data for Q3 2019 will be published October 23. 

Also by Jim Costello on RCA Insights: 

Rent Control Is Pushing Up US Apartment Cap Rates

Not All Uncertainty Can Be Laid at the Fed’s Table


Jim Costello

Jim Costello

Senior Vice President

Jim Costello has worked in the CRE space on issues of urban economics since 1990, including a 20-year stint at Torto Wheaton Research. Jim expanded the reach of the Torto Wheaton Research team developing forecasts of global market fundamentals. He also developed approaches to pair the forecast results with frameworks to answer investor questions on asset values and relative investment opportunities.

In the aftermath of the Global Financial Crisis, Jim provided advice to the Treasury Department and helped educate these professionals on commercial real estate performance. Jim is a member of the Commercial Board of Governors of the Mortgage Bankers Administration, where he helps policy makers understand the commercial real estate industry.

Jim is expanding the capabilities of the Real Capital Analytics team on issues of real estate market dynamics. Jim has a master’s degree in economics and is a member of the Counselors of Real Estate.