Despite Government Attempts to Boost Liquidity, Consumer Credit Continues to Contract, Stalling Recovery

Recent consumer credit data suggests that the economic recovery will be far slower than after previous recessions. Despite a moderating pace of job losses and heightened government spending, consumers remain cautious and are increasingly choosing to pare down debt rather than overextend themselves. Consumer credit balances fell by a greater-than-expected $12 billion in August, a 5.8 percent annualized drop, following a $19 billion decline in July. Lenders remain reluctant to extend credit, while consumers are increasingly cautious of taking on new debt due to uncertainty in the employment market.

The impact of tighter credit conditions and changing consumer behavior is most evident in revolving debt, which is comprised primarily of credit cards; revolving debt fell at an annualized rate of 12.3 percent in August. The recent decline was the second steepest monthly drop since the onset of the recession and signals that a consumer-led recovery will take some time to gain traction. The drop-off in revolving credit was surprising, however, given that personal consumption accelerated in August, which should support the use of credit.

Non-revolving credit, which is used to finance automobiles, home improvements and education, fell by $2.1 billion in August, a 1.6 percent annualized drop. The “Cash for Clunkers” program increased vehicle sales, offsetting some of the contraction associated with modest consumer demand. Non-revolving credit was expected to rise in September as more auto loans began to show up on credit balances, but the increase will likely be temporary, as consumers are putting off large purchases due to persistent concerns surrounding the weak employment market.

A growing propensity to save will have a dramatic impact on the speed and degree of the recovery, as consumption accounts for roughly 70 percent of gross domestic product. After peaking at 5.9 percent in May, the savings rate eased to 3 percent of disposable income in August, although that figure is much higher than in recent years.

The decreased use and availability of credit cards continue to hinder retail property fundamentals and lead to concerns heading into the holiday season. According to preliminary third quarter estimates, retail vacancy spiked 150 basis points year to date to 9.9 percent on negative net absorption of approximately 67 million square feet. Thus far in 2009, nearly 8,300 store closures have been announced, compared with 6,900 closures all of last year.

Merchants have trimmed inventories as a way to reduce costs and weather the recession. As a result, tenant demand for industrial space has slowed, pushing up vacancy 170 basis points year over year to 12.1 percent on negative net absorption of 88 million square feet.

Headwinds Blow in September; 263,000 Jobs Cut

The economy continues to face significant headwinds, as 263,000 jobs were cut in September, and the unemployment rate rose 10 basis points to 9.8 percent, indicating that the effects of the recession continue to linger. The worst of the job cuts may be over, though, as 768,000 positions were shed in the third quarter, compared with the elimination of about 2.1 million workers in the first quarter of this year.

The severity of the recession has been extreme, as more than 7.2 million positions have been lost to date. Despite the moderation in job reductions, significant hiring is not expected to resume until well into 2010. In a recent survey, 13 percent of chief executive officers expect to add workers in the next six months, an improvement from the second quarter, when only 6 percent intended to hire. Nonetheless, this will not offset the 40 percent who expect to cut additional workers. The survey confirms that most CEOs remain cautious, pointing to slow employment growth ahead.

The unemployment rate is forecast to climb to 10 percent by year end. Notably, the number of individuals unemployed for 27 weeks or longer increased from 2 million one year ago to more than 5.4 million in September. Individuals unemployed for 27 weeks or more account for 36 percent of all unemployed, the highest percentage in the past 29 years. The inability of the unemployed to find jobs will diminish the strength of a recovery by suppressing spending and the creation of new households. In addition, the average hours worked fell to 33 hours last month; employers will likely increase the hours of existing workers before resuming hiring.

In the apartment sector, nationwide vacancy rose 90 basis points to 7.6 percent in the first half of this year and is projected to hit 8 percent in the third quarter. The unemployment rate in the prime renter age cohorts remains high, which will suppress rental demand in the months ahead. The unemployment rate for individuals ages 20 to 24 is elevated at 14.9 percent. Among individuals ages 25 to 34, the unemployment rate has increased to 10.6 percent.

Weak employment continues to weigh on the office sector, where vacancy is projected to exceed 16 percent in the third quarter, compared with 14.5 percent at year-end 2008. Last month, 18,000 office-using jobs were eliminated, the lowest monthly total this year. As leases renew in the months ahead, however, the full effects of the loss of 1.2 million office-using jobs year to date will materialize.

Hotel employment is one of the few sectors that has expanded this year. Although hotel employment is down year over year, about 30,000 jobs have been added in 2009 as a result of new hotels opening. Additions to hotel supply, plus a sharp decline in room revenue, have resulted in an 18.3 percent drop in revenue per available room, or RevPAR, so far this year, creating a strain on the operations of many properties. Opportunities to invest in distressed properties are expected to increase in the near term.

Home Sales Data Disappoints; Recovery Likely Choppy

• The collapse of the housing market was one of the primary drivers of the recession, and the sector’s rebound will be an essential step toward an economic recovery. Recent home sales trends show that the market is improving slowly, but fundamentals remain weak and unlikely to spark a recovery in the near term. Year over year, the median prices for existing and new homes are down 12.5 percent and 11.6 percent, respectively.

• Sales of existing homes lagged expectations in August, falling 2.7 percent. New-home sales rose for the fifth straight month, ticking up 0.7 percent, but current levels are still down 3.4 percent year over year. Demand is expected to remain weak in the fourth quarter due to the expiration of the government’s first-time homebuyer subsidy and the troubled labor market. Soft demand will likely keep prices in their current ranges, limiting new building and construction employment into 2010.
• Inventory levels are contracting but still have a ways to go before reaching traditional equilibrium points of approximately four months to six months of stock. The inventory of new homes has fallen from 12.4 months in January to 7.3 months of supply in August. After peaking at 11 months of inventory last November, the current stock of existing homes is now 8.5 months, although not all foreclosed homes are counted in inventory, skewing this figure.
• While the first-time homebuyer credit has driven some renters to homeownership, the increase in foreclosures has sparked demand for single-family home rentals to a greater degree than apartments. Year over year through the second quarter, the single-family vacancy rate declined 30 basis points to 10.1 percent, while the apartment vacancy rate increased 150 basis points to 7.6 percent. The significant availability of shadow rental stock will continue to apply downward pressure on apartment rents and drive concessions higher.
• Home price declines have pushed down household wealth 12 percent from one year ago. Consumers have reined in spending as a result, causing a drag on retail property conditions. Specifically, retail vacancy is up 110 basis points year to date on negative net absorption of 50 million square feet.

Retail Sales Fuel Economic Momentum

• A 10.6 percent spike in automobile purchases in August generated a 2.7 percent surge in total retail sales, the largest monthly increase since January 2006 and the latest sign that the recession may be ending. Excluding the spike in auto sales, which was fueled by the “Cash for Clunkers” program, retail sales rose 1.1 percent during the month.

• Despite the uptick in August, retail sales remain down 5.3 percent on a trailing 12-month basis. Modest year-over-year increases may occur in the months ahead, but comparisons will be made against the depressed level of sales in the fourth quarter of last year. Indeed, retail sales remain constrained, falling 8.6 percent year to date through August compared with the corresponding period in 2008. Spending has suffered as a result of the weak labor market and will not rebound significantly until employers start to hire again.
• Some of the factors that contributed to the increase in retail sales last month may be difficult to sustain. A government rebate propped up auto sales in August, and, without the aid of significant intervention in the months ahead, demand may falter. A 5.1 percent jump in sales at gas stations attributable to higher prices also sparked a rise in retail sales; excluding autos and gas, sales rose by a tepid 0.6 percent in August.
• On a positive note, eight of 10 retail categories posted increases in sales in August, compared with only two categories in July. Some of the rises may be due to seasonal factors such as back-to-school shopping or the relief of pent-up demand. Housing-related sales declined in August, though, with sales of furniture down 1.6 percent and sales of building materials falling 1.2 percent. The rebound in the home sales, partly fueled by the government’s first-time homebuyer credit, appears to be insufficient to stimulate demand for housing-related goods thus far.
• Retail property fundamentals remain battered. In the first half of 2009, diminished spending forced stores to close, resulting in negative net absorption of 50 million square feet nationally. More stores have closed in the third quarter, and few retailers are expanding. As a result, vacancy will rise to the 10 percent range in the quarter as occupied space decreases and vacant new space continues to come online.
• Despite the surge in retail sales in August, hospitality properties are still suffering from the economic downturn. Preliminary data estimates occupancy of about 61 percent during the month, compared with 67.5 percent one year earlier. While government rebates to purchase autos caused retail sales to spike in August, the year-long attempt by hotel owners to boost demand by slashing rates has not improved property performance.

Consumer Credit Declines as Households and Banks Repair Balance Sheets

• While the latest Federal Reserve Beige Book showed the economy stabilizing, the July report on consumer credit balances illustrates the severity of the recession. Consumer credit, excluding real estate loans, fell at an annualized rate of 10.4 percent during the month, as the effects of job losses have forced many Americans to scale back spending and pay down debt. Consumer demand for credit has waned, but banks also have clamped down on lending. The credit freeze may be starting to thaw, however, as the proportion of loan officers reporting tightening standards on credit card issuance decreased in August.

• Consumers are taking unprecedented steps to rein in debt and bolster household finances ravaged by the recession. The $21.6 billion decline in consumer credit in July is the greatest since records were first kept in 1943 and the ninth monthly drop in the past 10 months. Consumer credit decreased only 62 times during the preceding 788 months.
• Significant declines were recorded in both types of consumer credit. Non-revolving credit, which is used to finance automobiles, home improvements and education, fell $15.4 billion during the month, marking an 11.1 percent annual drop. A rebound in August is expected, however, due to the “Cash for Clunkers” program. Revolving credit, primarily comprising credit cards, decreased at a 7.8 percent annual rate in July.
• The steady drop in consumer credit decreases the likelihood of a short-term rebound in consumer spending, which accounts for about 70 percent of gross domestic product. With nationwide unemployment approaching 10 percent and employment prospects remaining weak, consumers are expected to spend less, save more and continue to pare down debt.
• The decline in spending has resulted in fewer visits to shopping centers by consumers, contributing to negative net absorption of 23 million square feet nationwide in the second quarter. Additional store closures in the third quarter foreshadow higher vacancy, with the national vacancy rate expected to rise 210 basis points this year to 10.5 percent.
• The decreased use of credit cards to purchase airline tickets and pay for hotel stays was a factor in a 410 basis point fall in hotel occupancy in July. Occupancy was 64.1 percent during the month, as the number of rooms rented to guests slipped 4.3 percent from one year earlier. Similar results are projected in August. Lower hotel occupancy in most areas also places additional strain on the performance of bars and restaurants.
• Consumers continuing to spend less and pay down debt in the near term also will affect the performance of properties that store and distribute consumer goods. Since the recession started, the nationwide vacancy rate in industrial properties has climbed 240 basis points to 11.8 percent on negative net absorption of 51 million square feet.

CNBC Features Marcus and Millichap's Harvey Green

Reflecting on the commercial real estate market in the past year, with Mike Kelly, Caldera Asset Management and Harvey Green, Marcus & Millichap Real Estate Investment Services.

Job Cuts Diminish in August as Unemployment Hits 9.7 Percent

A slowing in job losses in August offers additional evidence that the worst of the recession has passed. During the month, employers nationwide cut 216,000 positions, raising to 955,000 the number of jobs eliminated in the past three months. By comparison, 2.1 million jobs were shed in the first quarter of this year. Despite the welcome moderation in employment losses, a transition to stabilized payrolls and a resumption of hiring may still be a few quarters away.

Two factors revealed in today’s employment report indicate that the pace of hiring new workers will be slow. Average hours worked was unchanged during August at 33.1. Employers will increase hours for existing employees before hiring new ones. In addition, temporary employment services, one of first sectors to hire after a recession, slashed 6,500 positions last month.

Job losses were spread across most sectors in August. Notably, retailers trimmed only 10,000 positions last month, compared with the loss of 43,000 jobs in July. The decrease in retail employment cuts is attributable to fewer seasonal staff reductions and the effects of the “Cash for Clunkers” program, which created 5,200 positions at auto dealers. Meanwhile, the education and health services sector generated 52,000 workers in August, with health care employers accounting for 47,000 of these jobs; this was the only sector to add positions last month.

The rising unemployment rate represents another concern clouding the prospects of an economic recovery. In August, the unemployment rate increased 30 basis points to 9.7 percent, the highest rate in 26 years; the unemployment rate is expected to peak at more than 10 percent in 2010. In addition, unemployment claims remain elevated. The high rate of joblessness will make it difficult for the economy to start a sustainable recovery, as consumer spending, a key driver of economic growth, will likely stay sluggish until employment prospects improve.

The slowdown in consumer spending and ongoing job losses in the retail sector are being reflected in retail property fundamentals. After rising 50 basis points to 9.5 percent in the second quarter, retail vacancy continues to increase across the country as more merchants close and national brands scale back new store openings. The weakness in fundamentals also has discouraged investors year to date, as transaction velocity is down significantly in most markets over concerns regarding near-term vacancy and rents.

The decline in employment this year is adversely affecting the office property sector, where tenants are still realigning space needs with reduced head counts. After 20 consecutive months of contraction, though, the pace of office-using job cuts is slowing, which may stem the erosion of fundamentals recorded year to date. So far in the third quarter, 124,000 office-using positions have been eliminated. Approximately 421,000 office jobs were shed in the second quarter, when negative net absorption of 20.6 million square feet was posted.