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.

Outlook: Goverment Programs to Restart Commercial Real Estate Credit Flows Beginning to Show Promise

Marcus & Millichap recently released our August 2009 Commercial Investment Real Estate Outlook, regarding Goverment Programs and their ability to restart commercial real estate credit flows. Below is an Executive Summary of the content, the full report is available by clicking here.

Executive Summary

Having weathered the recession with resilience throughout most of 2008, commercial real estate is now facing a dual challenge of rising vacancies and exceptionally tight debt financing. Both are largely the result of the escalation of the recession into a global financial crisis last fall.

Tangible results from government initiatives to stimulate the economy and loosen lending are modest at best; however, it is clear that government action helped to avert the worst-case scenario. Interbank lending has stabilized; investor and consumer confidence levels have moved off of recent lows; home sales are rising, albeit largely as a result of foreclosures; and aggressive cost-cutting is resulting in better-than-expected corporate profits. The U.S. economy and the availability of debt capital have a long way to go before returning to "normal," and many challenges remain. It appears, though, that conditions are improving and moving in the right direction.

Status of Government Programs: Pages 3-5

Term Asset-Backed Securities Loan Facility (TALF)

• TALF was expanded in May to include highly rated commercial mortgage-backed securities (CMBS). Spreads on AAA-rated CMBS have since narrowed dramatically.
• At its first subscription date in July, the legacy CMBS component of TALF received requests for $670 million in loans. All but one of the bonds submitted were accepted as collateral for TALF loans.
• Two REITs are expected to soon test the new CMBS component of TALF, with each projected to borrow up to $600 million against assets in their portfolios. A substantial amount of the capital raised will likely be utilized to pay down maturing debt.
• As a result of the lengthy ramp-up time for this program, TALF has been extended through March 31, 2010, for existing CMBS and through June 30, 2010, for newly issued CMBS.

Public-Private Investment Program (PPIP)

• PPIP was initially proposed to remove up to $1 trillion of legacy loans and securities from banks’ balance sheets but has been scaled back to roughly $40 billion in legacy securities only. The Treasury cited improving financial markets as the reason for the change.
• The Treasury recently released its list of prequalified fund managers to participate in PPIP. Each fund manager is required to raise $500 million in private capital. The government has committed $30 billion to PPIP, which will be used to match private equity capital raised and to provide financing.

Commercial Real Estate Market Conditions: Pages 6-7

• Commercial real estate sales volume during the first half of 2009 was down 75 percent from the same period last year and was 90 percent below peak levels recorded in the first half of 2007. The drastic reduction reflects a buyer/seller price expectations gap, as well as the tightening availability of financing. Buyer interest has been rising as more properties become available at realistic prices.
• Beyond hampering sales velocity, tight credit markets add another layer of complexity and challenge to commercial property owners, who have an estimated $550 billion of commercial mortgage debt slated to mature in the next two years. In many cases, lenders are focusing on minimizing further losses by modifying loan terms.

Emerging Opportunities in Commercial Real Estate: Pages 8-9

• As sellers become increasingly motivated due to maturing debt or general capital needs, a wide array of commercial properties will likely hit the market. To prepare for this opportunity, investors are defining strategies today to ensure they can move quickly when attractive assets become available. Pricing differentiation will persist, driven by property quality and location.
• In recent months, more buyers have re-engaged their pursuit of opportunities, and more owners have begun to accept market realities when pricing their properties. With ample capital waiting on the sidelines for the right time and/or opportunity to arise, the transaction market would likely be posting improvement already if financing was more readily available.
• Investors waiting to redeploy capital into commercial real estate until economic growth resumes or a central clearinghouse for distressed properties is established, similar to the Resolution Trust Corporation (RTC) in the early 1990s, run the risk of missing solid acquisition opportunities.
• The complexity of financial sector challenges has prompted an unprecedented amount of government stimulus and intervention, all of which require time to trickle through the system. Once credit markets are restored and economic growth resumes, investors will face significantly more competition from other prospective buyers when desirable acquisition opportunities arise.

Long-Term Outlook for Commercial Real Estate: Page 10

• Aside from retail, there was minimal overbuilding in recent years, and construction starts will remain limited through at least 2010. As a result, commercial property owners should have an opportunity to lease existing vacant space ahead of the next construction cycle.
• Payrolls were relatively lean heading into the downturn, and employers will need to rehire workers when a recovery takes shape. Consequently, the commercial real estate market could experience a relatively swift recovery compared to previous downturns.
• Demographic shifts and solid population growth in the coming years are expected to lend support to commercial real estate fundamentals. In addition to bolstering apartment demand, the growing population will require more services, reinforcing demand for other types of commercial space.