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With the U.S. economy continuing to extend one of its longest stretches of post-recessionary expansion, policymakers and market participants are beginning to ponder the timing and magnitude of the inevitable next recession. Whether it’s a year or eight years away, investors in U.S. commercial real estate are wondering what it will mean for CRE performance: Will certain markets or asset types be more immune to its negative effects than others? How will markets differ in the magnitude of the effects they experience, and in their speed to recovery?

To answer this question, in a recent study, we examined the effects of a major 2008-type recession on the 10 largest U.S. office markets. We analyzed how rents and vacancy would respond to severe drops in employment in each market, finding major response differences among markets.

Our key findings were:

• As office markets’ primary demand driver, employment growth rates are of great importance during a recession. Small declines (as expected in Washington, D.C., for example) will maintain better market performance than larger declines (e.g., Phoenix).
• The sensitivity of rents and vacancy to such changes in employment growth varies widely by market. Boston and New York, for example, show strong sensitivity, while San Francisco and Phoenix show low sensitivity.
• At a recession’s onset, the behavior of rents and vacancy rates is also influenced by their current levels relative to long-run trends. Higher rents (and lower vacancy rates) versus long-run trends (as in San Francisco) put markets at higher risk of larger negative adjustments; markets closer to trend (e.g., Phoenix) are at much lower risk.

When the recession inevitably comes, taking account of the differences between markets and the factors that drive them will play a crucial part in preparing investment portfolios for recessions, and in identifying investment opportunities when the economic cycle returns to its growth phase.

Estimated Rent and Vacancy Response to a Deep Recession Scenario

Source: CBRE Econometric Advisors, Q2 2016.