Now it is all but certain that the Republican “red wave” in the U.S. midterms didn’t materialize as some had expected. Democrats performed better in federal, state, and local elections than even some in the party seemed to anticipate, narrowly maintaining control of the U.S. Senate and winning some surprise gubernatorial races. Polling isn’t nearly as reliable as it used to be, as some pollsters said before Election Day that many races were tightly contested and the results were almost unpredictable. So, maybe the surprising outcomes shouldn’t have been too shocking after all.
Now that the dust is (mostly) settled, some commercial real estate professionals are surveying the impact of the midterms on the industry. Midterm elections rarely dictate a significant shift in national fiscal policy, and this year will be no different. Fiscal and legislative policy for the past two years under a unified Democratic government has been expansionary, with several big-ticket pieces of legislation passed, such as the Inflation Reduction Act. But now, Republicans look poised to take back control of the House of Representatives, and even though Democrats maintained control of the Senate, they did so with the slimmest of margins.
The result will be a divided government and a more gridlocked Congress. National policymaking will likely slow down, as President Biden will be unable to gather the votes to pass sweeping legislative measures and will likely oppose signing anything that lacks bipartisan support (a foreign term in today’s political climate). For commercial real estate, though, a divided government has historically been positive for property prices. The real estate industry is also inherently local by nature, so state and local election results may have a more significant impact on the market than what’s happening on the national scale.
Despite whatever changes happen because of the midterms, the apolitical Federal Reserve and its efforts to fight inflation will continue to have the biggest impact on the real estate market. Inflation has started to cool slightly, so the Fed may soon slow down the pace of aggressive rate hikes. Rising interest rates have already affected the commercial real estate industry, leading to pricing uncertainty and higher borrowing costs. This will likely continue for the foreseeable future, along with a looming recession many see now as inevitable. The hotly contested midterm elections have garnered tons of attention and will impact real estate, but what’s happening with the Federal Reserve will have the biggest influence.
Divided we prosper?
Most midterm elections lead to a divided federal government. The party not in power has gained seats in 17 of 19 midterm elections since World War II, averaging a gain of 27 House seats. President Biden’s Democrats did historically well for a party in power in the recent midterms, but it still seems certain that Republicans will win the House. As of November 15th, Republicans were one seat away from gaining control. The Democrats maintained Senate control, but the end result is, as usual, a divided government after a midterm election.
Political gridlock, though, is not necessarily a bad thing for the economy or real estate asset prices historically. GDP growth averaged an above-trend rate of 2.7 percent annually during times of divided government dating back to WWII, with equities yielding 7.9 percent. Stock prices also tend to rise immediately after midterm elections as investors get more clarity on policy. In the first three quarters of midterm election years since WWII, median equity market returns were -1 percent, 2 percent, and 5 percent, respectively. But in the fourth quarter following the elections, median returns jumped to 8 percent.
The stock market may get a quick boost now that the midterms are over, and similar historical trends have happened for commercial real estate returns. In the two years following midterm elections, annual returns for all property types averaged 9.4 percent, dating back to 1979, compared to 8.8 percent in the two years preceding midterm elections. While that seems promising, there are some caveats to consider. For example, the two years before the 2010 midterms were the worst time for commercial real estate returns on record following the financial crisis of 2007 to 2009. More recently, these past two years leading up to the midterms have seen the industry and multifamily markets perform well above the historical average. So, while election cycles impact real estate asset prices, the economy and property market fundamentals still matter more.
All politics is local
The national elections gained much of the attention in the midterms, as they always do, but local races matter just as much, if not more, for real estate. There were 36 gubernatorial elections nationwide in this midterm cycle, and they all had implications for how state governments handle crucial real estate policy topics like affordable housing, taxes, and infrastructure projects. In many states like Texas, Florida, and California, incumbents like Greg Abbott, Ron DeSantis, and Gavin Newsom won easily, so it’ll remain business as usual for the real estate industries there.
Incumbent Republican Georgia Governor Brian Kemp held off Democratic challenger Stacey Abrams again, and he was the favored candidate for real estate in many cases. In New York, Democratic incumbent Kathy Hochul beat Republican challenger Lee Zeldin in a tight race, and Zeldin drew much support and donations from the real estate industry down the stretch as the polls narrowed. In Pennsylvania, Democrat Josh Shapiro won by a wide margin over Republican Doug Mastriano. The race was largely defined by abortion, as Mastriano vowed a total abortion ban in the state if elected. An abortion ban could’ve had an impact on commercial real estate, perhaps slowing down economic development. This possible outcome was watched by high-profile companies like Duolingo, which said it would relocate its headquarters out of Pennsylvania if abortions were outlawed in the state.
Beyond the governor’s races, several ballot measures nationwide directly impacted real estate. Many ballot measures were focused on rent control ordinances, which have picked up steam nationwide recently. Perhaps the most closely watched of the ballot measures was in Orange County, Florida, where voters overwhelmingly approved a rule preventing existing apartment owners from increasing rents at a rate higher than the region’s inflation rate.
There’s pending litigation that will prevent the law from going into effect. Orlando, located in Orange County, saw annual rent growth of 16.2 percent in July, the highest of any U.S. metro. If the ordinance is adopted, nearly half of the 230,000 existing multifamily units in the county could be affected. But if rent growth slows down, as it appears to be doing now, the number of units affected could be less than 5,000.
Another local race, though not a ballot measure, closely watched by real estate professionals was the Los Angeles mayoral contest between developer Rick Caruso and Democrat Karen Bass. As of publication, the race was still too close to call, but Bass was ahead by more than four points in the most expensive mayoral race in the city’s history. The billionaire Caruso dramatically outspent Bass during the campaign and gained support from the real estate industry for his platform on fixing homelessness and the city’s housing shortage. Caruso spent $100 million of his own money on a pledge to clean up the city.
What’s most important is apolitical
Despite what happened in the midterms, most eyes in the commercial real estate industry will remain locked mainly on the Federal Reserve, which, like the Supreme Court, is designed to be apolitical and independent. Federal Reserve governors are appointed by the President and must be approved by Congress, but its decisions on monetary policy are made autonomously and not subject to approval by the President or federal government. Unlike a Senator or House Representative, regular Joes and Janes don’t get to vote for Fed appointees as much as some people would like to.
The Fed is currently staging the most aggressive policy to raise borrowing costs in recent memory, and the impacts are being felt in commercial real estate. At its November meeting, the Fed raised interest rates by 0.75 percent for the fourth time this year, bringing the benchmark interest rate to a target range of 3.75 to 4 percent, the highest since early 2008. The Fed has raised rates at six consecutive meetings now, which it hasn’t done since 2005. And it hasn’t been since the 1980s that the Fed has raised rates by 3.75 percentage points in a single year.
When will the rate hikes end? No one knows for sure, of course, but Fed Chairman Jerome Powell has said they’ll ease the hikes only when they see significant progress on the cooling of inflation. That could be beginning to happen, as the latest Consumer Price Index showed that inflation’s pace slowed in October, rising 7.7 percent for all items over the past year. The rate of inflation increase in September was 8.2 percent, so progress has been made.
The Fed indicated during the November meeting that it may slow the interest rate increases in December. Most economists expect the rate hikes to stop at some point in 2023, peaking at a target range of 4.75 to 5 percent by the end of next year. If that happens, the Fed would have taken rates to a 16-year-high when everything’s said and done.
Rising interest rates are already impacting commercial real estate, and they will continue to do so. For example, according to Green Street, commercial property prices in all asset types are down 13 percent so far this year, primarily due to the rate increases. It’s still important to put things in historical perspective, though. Inflation remains at 40-year-highs, but interest rates are nowhere near the 6.5 percent of the 2000s or the record high of nearly 20 percent in 1980. “In terms of absolute levels, and in view of history, current interest rates are still at attractive levels,” Mike Kraft, Head of CRE Treasury at JPMorgan Chase, recently said. “Generally, I would say this is a great time to do business—before additional rate movements kick in.”
The impact of higher interest rates on commercial real estate has been mixed so far. The era of relatively cheap money for commercial real estate borrowers has ended, and debt options aren’t nearly as strong. It has investors shifting focus to high-quality properties in solid and resilient markets, and there are still plenty of outliers, such as Nashville, Tennessee, which Cushman & Wakefield recently ranked as the top U.S. real estate market to watch in 2022. When inflation starts to cool, as it may be now, and whenever the situation in Ukraine and Russia stabilizes, there should be more stability in debt markets.
The midterm elections will have a mixed impact on commercial real estate, as they always do. Congressional gridlock and a divided government mean the Biden administration’s big-ticket legislative agenda will slow down. Historically, property prices have performed surprisingly well in the two years following midterm elections, so the commercial real estate industry may get a post-election bump in the years leading up to the presidential election in 2024.
State and local races, including ballot measures, may impact real estate professionals more than what’s happening on the national stage. But above all else, the doings of the Federal Reserve will have the most influence on real estate, more than the midterm results. Election Day was a day to watch for the real estate industry, but the dates circled on most calendars are December 13th and 14th, when the Federal Reserve meets next.