IF THE ECONOMY IS IMPROVING, WHY DOES IT FEEL LIKE IT IS STUCK IN THE DITCH?
The news is full of happy talk about economic recovery and growth. The press keeps reporting about how the economy is growing. For example, payroll processor ADP recently reported that private sector employment numbers were up by 209,000 in March. That’s good news! Fed Chairman Bernanke has recently said that he thinks the U.S. economy will return to its long-term growth of around 3 percent a year despite the weaknesses it still faces. However, despite all that optimism, the tide hasn’t raised all the commercial real estate boats yet. At least not where I am based, in Southern California. Why not?
There are still a lot of negatives affecting the economy that have a disproportionate effect on commercial real estate – or at least on some parts of the CRE markets. Since consumer spending fuels about 70% of the economy, the businesses that sell goods and services to consumers suffer – and don’t buy or lease more commercial real estate – when consumers aren’t buying. (And, of course, the other businesses, which sell to consumer-facing businesses, also slow down, as does their demand for real estate.) Here are the major factors and trends that appear to be limiting consumer spending out here in the real world beyond the Beltway:
Employment: Despite the recent advances in employment, there are still a lot of unemployed and underemployed folks out there. We lost a lot of jobs nationally, and have not regained them. Underemployed and unemployed folks don’t buy things – so consumer spending is down.
Geographic Variations: In parts of the country where the local economy boomed due to debt-fuelled growth in mid 2000s, the economic recovery is very slow (see NY Times article today). Also individual wealth disparities have heavily affected what areas have been able to “ride out” the rough times: wealthier areas have done better.
For example, Texas has generally been growing due to its oil and energy fuelled economy, and to a good market for its agricultural products. The "sand states" (Florida, Arizona, Nevada), where easy real estate financing caused a bubble that has now popped are generally weak. California, which is a huge state, has some bright spots, and some weak areas. Notably, in Northern California, Silicon Valley is generally doing well, as its economy is being driven by tech, but the Sacramento area is weaker, reflecting diminishing government expenditures and the crash of speculative commercial real estate ventures predicated on growth. Similarly in Southern California, the economy is bifurcated: coastal areas and Los Angeles’ West Side are generally strong reflecting productive parts of the economy (including health care, entertainment, and biotech) . Inland California areas are weak, especially where "drive to qualify" for a mortgage reigned and where there are few wealth generating businesses producing goods and services.
Direct Burdens on Consumers. Consumers are burdened directly by the overhang of private debt: many have underwater residential mortgages or have been foreclosed; many others carry a lot of credit card debt; still others struggle to pay their student loan debt. All of this existing debt limits consumers’ ability to spend. In addition, most consumers have been coping with stagnant wages, high unemployment, and low job mobility for several years. Recently, gas prices have taken a hike, which further limits consumer spending. Finally, lingering public debt will burden taxpayers. Nationally, we need to pay for our war debts, entitlements, and health care. California and many other states are grappling with how to fund governmental deficits, public employee pensions and unemployment relief.
Potential Additional Burdens on Consumers. A lot of uncertainty surrounds the issues below:
- European debt crisis
- Possible military action in Iran
- Political brinksmanship
- Technology-caused efficiency eliminating jobs (for example, Best Buy's recent decision to close 50 stores)
- Environmental problems: sustainability, power availability, and environmental degradation
Consumers don’t know what will happen, or how bad the impacts of these potential burdens will be; that lack of certainty drives more savings and less buying. While that pattern (frequently referred to as the “paradox of thrift” benefits individual consumers, their thrift limits economic growth overall.
Trend: Risk Shifting to Individuals. Over past 20 years, many risks were shifted from groups, such as government or companies, to individuals. Many companies quit providing pensions, instead providing only self-funded and managed 401Ks. Public education, which used to provide not only the basics, but also art, music, and practical courses such as wood shop and drivers’ education, radically shrank its scope. Now, parents must pay separately for tutors to prepare their children for college entrance exams; must pay for separate lessons for music, dance, art and acting; and must hire private instructors to teach their kids to drive. Health insurance plans have narrowed their coverage. Due to their costs, employers have made health insurance less available and more expensive to their employees. Is it any surprise that rising medical costs have become one of the major drivers of foreclosures and housing loss?
Trends: Demographics. Retiring baby boomers (born 1946 - 1964) now range from 66 years old to 48 years old. Particularly the older baby boomers are spending less, working longer due to stock market and real estate losses. Some of the trends above have also resulted in a generational shifting of burdens from older people to the younger people. Since such older people have typically already acquired many of their major household goods, they have less need to buy. By contrast, younger people who are finding it harder to find good jobs, cannot buy as much as the boomers did at their age. This also constrains growth in the economy.
Demographics aren’t all bad: changing demographics are likely to drive job growth in businesses serving older Americans. Many of the jobs becoming available are not high wage jobs, however; many are service jobs such as health care, senior assistance, and aging in place services. Senior housing may come back after its current slump - if the residential real estate market recovers (since the sale of an older person’s prior residence usually fuels his or her purchase of retirement housing) or if another purchase mechanism is developed. Additionally, senior housing may not yet seem “cool” enough for the baby boomers, but when the leading edge of boomers hits their 70s in 5 - 8 years, health concerns may start driving their housing choices more than lifestyle will.
Given all these negatives, it is not surprising that many folks – even those working in secure jobs – have tightened up their spending habits, choosing to save more and spend less. Maybe that’s less true in the East Coast cities where many of the economic reports are generated, and where the local economies rely much more on finance and on US governmental spending than does our local economy here in Southern California. But most of the folks I talk to here tell me how they’ve changed their spending habits and increased their savings. While this trend probably is prudent and makes sense on an individual basis, it does not help businesses seeking to increase sales do so; and in turn, those businesses are not eager to splash out with more money for more sites (whether office, retail or industrial) since their sales are not growing steadily. For these reasons, it appears the economic recovery will continue to be slow and bumpy at best, despite the happy talk.