A Commercial Real Estate Dissection of Third Quarter GDP

While the formal dating of the recession's end is a privilege that resides with the NBER, news of the economy's expansion has trumped a formal announcement -

The headline result that prompted yesterday's 2.05 percent rise in the Dow masks a wealth of detail regarding the underlying drivers of growth. As described below, spending on automobiles - fueled by the Car Allowance Rebate System program (more commonly, the "CARS" or "Cash for Clunkers" program) - was a particularly important contributor to the third quarter's result. On the other hand, declining investment in non-residential property development was a significant drag.

In spite of robust growth in aggregate output, the advance estimate of GDP should be considered carefully. Automobile sales and improving conditions in the residential market were both important drivers of the result. In both of these areas, however, short-term government interventions have contributed significantly to the positive results. At least in the case of personal consumption expenditures, we can reasonably anticipate a smaller contribution to growth in the fourth quarter.

Drivers of Growth in the Third Quarter

+3.4 percent | Contribution to GDP: 2.36 percentage points

Consumers loosened their purse strings over the summer, driving the strongest growth in consumption since the first quarter of 2007. According to the advance estimate, personal consumption expenditures (PCE) grew by 3.4 percent in the third quarter, more than reversing the second quarter's 0.9 percent decline. The benefits did not accrue to retailers, however. Increases in spending on non-durable goods and services were muted. Rather, the total increase in PCE was dominated by a 22.3 percent rise in durable goods spending corresponding with a sharp rise in automobile production and purchases.The increase in auto production, heavily dependent upon the CARS program, contributed 1.66 percentage points to headline GDP growth. Put another way, GDP growth in the third quarter was approximately 1.8 percent (instead of 3.5 percent) when controlling for the total contribution of the auto industry and auto purchases. The summer's increase in auto activity is not expected to persist into the fourth quarter. Following the expiration of the CARS program, production and sales are expected to fall. As a result, the auto sector's contribution to GDP growth may turn negative again in the fourth quarter.

Outlook The sharp rise in headline consumer activity is unlikely to persist into the fourth quarter. Consumer sentiment is rising, pushing savings rates lower and spending rates higher. But job losses will continue to weigh on consumers' aggregate incomes. Absent the CARS program or a similar consumption subsidy, we can expect that spending will grow more slowly in the fourth quarter than in the third. For retailers, discretionary spending increases will remain lackluster until job growth resumes. This is because job losses constrain aggregate income growth. In the third quarter, disposable personal income - income after taxes - fell by 0.7 percent even though the economy expanded. Ultimately, core retail lenders and borrowers will have to wait for measurable improvements in space demand  driven by stronger consumer traffic.

Federal Government Spending

+7.9 percent | Contribution to GDP: 0.62 percentage points

Total government spending increased by 2.3 percent in the third quarter, reflecting a 7.9 percent jump in federal government outlays and a drop in spending by state and local governments. While the common perception is that federal spending on domestic recovery programs has dominated the rise in outlays, spending on national defense has been increasing at a faster rate than non-defense programs. Defense spending increased by 8.4 percent in the third quarter, outpacing growth of 6.8 percent in non-defense programs. In the second quarter, defense spending increased by 14.o percent; non-defense programs, by a more modest 6.1 percent.

Residential Investment

+23.4 percent | Contribution to GDP: 0.53 percentage points

Following 14 consecutive quarters (3 and ¾ years) of declines, residential investment turned positive in the third quarter, rising by 23.4 percent. The increase corresponds with the rise in new residential construction activity reported by the Census, both in terms of construction starts and value put-in-place. Chained (2005) dollar investment in the third quarter was $362.9 billion at a seasonally adjusted annual rate, up from $344.4 billion in the second quarter, but 22.3 percent below the $443.3 billion of investment just a year ago. Overall, residential investment remains well below long-term average levels.

Drags on Growth in the Third Quarter

-9.0 percent | Subtraction from GDP: 0.32 percentage points

Investment in non-residential structures, including commercial real estate, fell by 9.0 percent in the third quarter. This is the fifth consecutive quarter of declining non-residential activity. The GDP estimate is consistent with data from the Census Bureau which shows that commercial real estate construction spending in August fell to $372.6 billion (SAAR), down from $382.6 billion in June (the final month of the second quarter) and by 10.5 percent from the same time last year.

Outlook Amongst the principle areas of decline in commercial construction value put-in-place, office construction spending has fallen by 30.0 percent over the last year through August; shopping center spending, by 43.0 percent; shopping mall spending, by 37.9 percent; industrial warehouse spending, by 44.2 percent; and, hotel and other lodging spending, by 35.5 percent