The contraction of the U.S. economy at an annual rate of 0.3% in the third quarter is a dismal sign for commercial real estate performance in the year ahead, according to leading economists. A decline in consumer spending was the major reason behind the third-quarter drop in gross domestic product (GDP), with consumer spending down 3.1% for the period.
“There can be very little doubt that the USA, and indeed every major economy in the world except China, is in a recession,” according to James Smith, chief economist for Parsec Financial Management in Asheville, N.C.
Smith expects that the National Bureau of Economic Research will eventually confirm that the economic decline started in December 2007, when industrial production and nonfarm payroll employment began to wane.
One surprising finding in the third-quarter GDP figures is that private spending on commercial real estate structures rose at a seasonally adjusted annual rate of 7.9%. “That means commercial real estate, which normally lags the real economy by a year or so, is doing that again,” says Smith.
Commercial real estate fundamentals have held up well to this point, except for all the difficulties on the financing side, Smith points out. “But 2009 and probably 2010 are going to be dismal years for commercial real estate.”
Hessam Nadji, managing director of research for Marcus & Millichap Real Estate Investment Services based in Encino, Calif., agrees that while the third-quarter GDP contraction is minor, there is more of a slowdown to come since the third-quarter figures lag the full brunt of the financial crisis that unfolded in September and October.
During the past two months, the commercial paper market seized up, as did lending activity, and the stock market nosedived after Lehman Brothers filed for Chapter 11 bankruptcy protection in mid-September. There have been some signs of the credit markets loosening in recent weeks, but nothing substantial. Nadji expects GDP to contract again in the fourth quarter, and perhaps even during the first quarter of 2009.
The economy to this point has remained relatively resilient amid the housing slump and the credit crunch, says Nadji, consequently the fundamentals of commercial real estate have held up well. Now that a recession is clearly evident, Nadji expects a weakening in commercial real estate performance across the board.
More office sublease space is likely to spill onto the market, apartment properties will suffer as household formation slows down, and retail properties will feel the impact of a consumer cutback to a larger extent than they’re seeing now, predicts Nadji. And as commercial real estate fundamentals weaken, there will be more downward pressure on property values.
On the positive side, Nadji doesn’t see any outcome for the U.S. economy that is comparable to what occurred during the Great Depression of the 1930s, or even a severe recession. “Our findings are not quite that negative. The reason we believe that is the extreme measures that have been taken by the [world’s] central banks, and the fact that we do have a system in place to prevent some of the past situations,” says Nadji. “The dynamics during the Great Depression were different, from a government point of view.”