The net loss of 4,000 jobs in August took the nation by surprise when the figures were released by the Bureau of Labor Statistics on Sept. 7 and reinforced forecasts for the absorption of commercial space to slow this fall. Although the employment report cast a grim light on the state of the economy, experts believe it cemented the resolve of Federal Reserve governors to stimulate growth by cutting the fed funds rate by 50 basis points on Sept. 18.
The preliminary results in the August job report were particularly disappointing for Wall Street, which had expected the economy to generate more than 100,000 jobs in August. While the totals are still subject to revision, the trend in recent months has been for the U.S. Labor Department to make downward adjustments: June's gain was nearly cut in half to 69,000 new jobs from a preliminary estimate of 126,000, while July's net growth of 68,000 was revised from an initial estimate of 92,000.
It's going to be difficult for economists and pundits to dismiss the negative jobs number as a one-month anomaly that doesn't constitute a trend, says Dr. Sam Chandan, chief economist at Reis Inc. “There's increasing evidence that the economy, broadly, is being impacted by the downturn in the housing market.”
Upon closer examination of the report, some numbers really jump out. The manufacturing sector eliminated 46,000 jobs in August, the biggest monthly drop in manufacturing payroll since July 2003 when 61,000 jobs in that sector were eliminated. The contraction may reflect manufacturers' anticipation of a credit-induced slump in consumer spending (See chart).
The unemployment rate remained deceptively unchanged at 4.6%, due to a 340,000-person decline in the size of the labor force that offset net job losses. Retail grew by 13,000, while professional and business services — a chief driver of office demand — netted uninspiring growth of just 6,000 jobs.
The slowdown in payroll growth is sobering for commercial real estate investors, who depend on job growth to fuel demand for space. Further job losses could push the office vacancy rate to 13.2% at year's end from 13% at midyear, according to Robert Bach, research director at Grubb & Ellis. “I would not be surprised to see that we lost more jobs in September. A lot of layoffs in the housing and mortgage industry were announced after the survey for the August report,” Bach says.
Researchers were already predicting that new construction, which is adding 50 million sq. ft. of offices to the more than 3.7 billion sq. ft. in the national inventory, would nudge vacancies upward in the second half of the year, ending a three-year run of steadily declining vacancy rates.
But those forecasts assumed that monthly job creation would only slow to about 135,000, down from an average of 148,000 per month in the second quarter. “With the slowdown in net new jobs, the downside risk is even more significant than economists had anticipated,” Chandan says.
Hessam Nadji, managing director of research services at real estate services firm Marcus & Millichap, began warning of slowing job growth in May when the government's household survey showed a decline of 468,000 in total employment compared with the previous month's figures.
While economists generally consider the national payroll survey to be a more accurate determinant of current employment, the household survey has proven to be a better predictor of shifts, Nadji says. The payroll survey polls employers, while the other survey queries the job status of adults in a sampling of households.
Economists may have expected employment to taper, but few expected growth to plummet into negative territory so quickly. Nadji blames the credit crunch for accelerating what would have been a more moderate pace of declining job creation this summer.
Even so, researchers expect office and retail to achieve positive rent growth in the second half of 2007 despite some increase in vacancy. Retail developers will apply the brakes on shopping center construction if their anchor tenants delay expansion, Nadji says. Bach, the Grubb & Ellis researcher, agrees that office construction is ramping up but contends that tenants have already committed to absorb much of that space.
Kick-start from the Fed
For real estate investors, the best news last month concerning future job creation came not from the Labor Department but from the Federal Open Market Committee, which lowered the Fed funds rate by 50 basis points to 4.75% on Sept. 18. Cutting the benchmark rate for overnight lending set the stage for an economic recovery that is expected to start showing up in jobs and GDP growth next spring.
Even before the Fed slashed rates, futures traders were pricing in a Fed funds rate cut of 25 to 50 basis points in anticipation of the vote. Yet economists had expected the Fed to cut rates as early as the first quarter this year, and were disappointed at each Fed meeting. Why was the September vote any different?
It's a good bet that job losses weighed heavily in the Fed's rate decision. After all, the Fed made its series of 17 quarter-point rate increases from June 2004 through August 2006 in order to slow the economy and curb inflation. Job losses are one indication that the Fed's action is finally having the desired effect of limiting the consumer's ability to spend and drive price appreciation, according to John Burford, senior vice president and investment portfolio manager at the International Bank of Miami.
“When the Fed raises rates like they did beginning in 2004, the idea is to put the credit-sensitive sectors under pressure. That's automobiles and housing, and that's what they want people not to buy,” Burford says. “When they think they've created enough pain to moderate inflation, then they lower rates.”
The jury is still out on whether the Fed made the right move on Sept. 18 or acted too soon. It wasn't until June that the personal consumption expense deflator — a key measure of inflation — fell to 1.9% year-over-year growth, below the Fed's preferred inflation threshold of 2%. Fed governors may have felt compelled to intervene in the credit crisis by increasing liquidity, but there is a real danger that the rate cut will increase inflationary pressures. Some argue that increased liquidity will fuel further risky lending.
“If there were no underlying concerns about inflation, this wouldn't be a difficult choice,” says Chandan. “But in as much as the Fed is weighing [inflation and liquidity], there is a lot of disagreement.”
Time will tell
With a rate cut in place, the wheels of economic renewal are already turning. The Dow Jones industrials closed 233 points higher on Sept. 18 over the previous day's close, buoyed by the perception that a diligent Fed will avoid recession. Many consumers benefited from the 50-basis-point drop to 7.25% in the prime rate, which serves as a base for most credit card rates. By easing consumers' debt burden, the prime cut may stimulate the consumption that makes up more than two-thirds of the economy.
Unfortunately for investors and developers waiting on job creation to increase demand for space, it typically takes six to nine months for interest rate changes to bring about measurable employment shifts. Why so long? Restoring necessary liquidity to the market requires lenders and investors to overcome fears that have led to widespread intolerance for risk. That will take time.
“The Fed has tried to make things right, but they cannot put Humpty Dumpty together again,” Burford says. “For people who've lost a fortune investing in subprime mortgage products, they cannot make them willing to take risks again.”
And lest we forget, serious problems are still on the table, from the subprime meltdown to a housing recession and weakening employment growth, says Chandan, the Reis economist. “It would be a mistake to think a rate cut, on its own, will solve all our problems.”
— Matt Hudgins