Savings Are Good, But May Slow Recovery

Mark Gongloff recently reported in the Wall Street Journal an interesting piece which may affect the long-term valuation models of many real estate investors. In our discounted cash flow models, we must assume a certain stabilized growth rate and over the recent years, those growth rates were likely higher than we expect to see going forward, according to Gongloff. The article references a recent San Francisco Fed Paper which predicts as much as a 75bps drop in consumption growth each year due to increased savings rates. The latest personal-income and personal-spending data is reported at the BEA website. Below are some highlights of the article:

• Strength of the recovery dependent upon savings accounts


• Combination of falling incomes and higher spending means consumers' savings will likely fall after surging to 6.9% in May


• Long-term path for savings is inevitably higher


• Ratio of household net worth to disposable income is at its lowest level since 1992


• Current net-worth figures are consistent historically with savings rates of between 6% and 10%


• If savings merely rise to the low end of that range, $700 billion in consumer income could be removed from GDP next year


• A 10% savings rate between now and 2018 would shave three-quarters of a percentage point from consumption growth each year


• High savings rates could spur demand for Treasury bonds and short-term corporate debt, keeping interest rates low

Small GDP Contraction Signals the Recession is Winding Down

• During the second quarter, gross domestic product (GDP) beat consensus expectations, declining at a far more modest rate than in preceding quarters. The economy is still contracting; however, the recent data suggest that the recession is nearing an end and that a recovery could begin to take shape in the coming months. GDP fell at an annualized rate of 1 percent in the second quarter, compared to annualized declines of 6.4 percent in the first quarter and 5.5 percent in the fourth quarter of 2008. While the more subdued decline is a welcome sign, the depth of the downturn has been significant; GDP has now contracted for four consecutive quarters for the first time since the government started tracking the data in 1947.


• The economic stimulus has begun to kick in, limiting the recent decline in GDP and likely supporting modest growth in the coming quarters. Government spending increased by an annualized rate of 5.6 percent in the second quarter, compared to a 2.6 percent drop in the first quarter.


• In contrast to the acceleration of government spending, consumers are holding back. Personal consumption expenditures, which account for approximately two-thirds of GDP, fell at an annualized rate of 1.2 percent in the second quarter, after ticking slightly higher in the first three months of the year. Severe job losses and persistent weakness in the housing market have weakened consumer demand, which will likely result in a slower recovery than in past cycles. A “U-shaped” recovery, or one where the economy comes out of a recession with an extended period of low growth before posting solid gains, is increasingly likely.


• In response to softer consumer demand, businesses are scaling back inventory levels. While a reduction in inventories is a drag on GDP, it also can provide fuel for a recovery. When spending begins to gain momentum, businesses will have to crank up production, rather than pull from existing stockpiles of goods, to meet the new demand. The industrial sector will be the primary commercial real estate sector to benefit from increased production.


• Reduced consumer demand is weighing on retailers. During the first six months of 2009, negative net absorption of retail space topped 30 million square feet, and vacancy increased 110 basis points to 9.5 percent. With demand softening, property owners have dropped rents and offered greater concessions, resulting in decreased investment activity and rising cap rates, particularly among multi-tenant properties.