Heading into the third quarter of 2012, the economy seems to have gone on vacation. The pace of economic activity slowed noticeably in the second quarter and most indicators point to an environment of suspended expectations. The presidential election and legislative issues on the horizon are weighing heavily on the minds of market participants. Viewed against this backdrop, commercial real estate continues on a positive path towards recovery, but with tempered expectations.
Looking at economic activity as measured by gross domestic product (GDP), it is obvious that fundamentals are in a slowdown. Based on the Bureau of Economic Analysis’s second estimate, GDP rose a mere 1.5 percent in the second quarter of this year. The anemic figure comes in the wake of a soft first quarter rise of 2.0 percent.
Both consumers and businesses moderated their spending. For consumers, weak employment growth, stagnant wages, rising prices and low confidence collaborated to inhibit spending. For employers, volatile financial markets, increased regulation and rising uncertainty over the outcome of the presidential election and the 2013 legislative environment outweighed record profits and cash reserves, leading to restrained interest in expanding payrolls. With muted activity in the markets, governments at all levels continued to cut expenses.
A bright spot for business, international trade gained during the second quarter. Both exports and imports of consumer goods increased 6.0 percent. Exports of services rose 3.7 percent, while imports of services advanced 5.5 percent, leading to a negative net export figure.
Lack of employment growth comprises the core of the current economic condition. Following a series of disappointing quarterly earnings reports, several major companies have been announcing layoffs during the quarter. After a positive first quarter, when the private sector added a net 711,000 payroll jobs to the economy, the second quarter generated a meager 369,000 jobs.
Goods-producing industries (manufacturing, mining, construction) added a net of only 29,000 jobs, as construction companies shed 37,000 workers. Service-providing industries provided the remainder—340,000 jobs. Supporting commercial real estate, professional and business services added 113,000 jobs, education and health added 100,000 jobs, while information, financial activities and leisure/hospitality industries contributed an additional 68,000 jobs.
Meanwhile, government jobs fell by 40,000 during the second quarter, making it the eighth consecutive quarterly decline. At the federal level, there were 11,000 payroll jobs cut, while at the state and local level, governments cut a net of 29,000 jobs over the quarter.
The trend was also mirrored in the figures for first-time unemployment insurance claims. The number of weekly claims—which had steadily declined towards 360,000-per-week from 2011 to the first quarter of this year—jumped to 382,000-per-week during the second quarter. Following a similar pattern, the unemployment rate rose from 8.1 percent in April to 8.3 percent in July.
Not surprisingly, consumers remain wary in their outlook of the second half of the year, as illustrated in the two main measures of consumer confidence and sentiment. The consumer confidence index compiled by the Conference Board—a measure that considers respondents’ general feelings about the job market and their finances—decreased from 67.5 in the first quarter to 65.3 in the second quarter. Meanwhile, the University of Michigan survey of consumer sentiment edged up to 76.3 during the second quarter, from 75.5 in the first one. Both are below long-term trends.
Commercial Real Estate
With a slowing national economy, demand for commercial space remains positive, but the growth outlook has been moderated. Sluggish employment is slowing demand for office space. Retail spaces are still working through supply issues and weak consumer demand. Industrial warehouse spaces are benefiting from increasing trade, while apartments remain a strong performer.
For office properties, net absorption is expected to total 24.1 million square feet this year, leading to a projected 16.1 percent vacancy rate for the year. The slight decline in vacancy is likely to be accompanied by a 2.0 percent rise in rents. Absorption in the industrial sector is expected to reach 59.9 million square feet this year, resulting in a 10.8 percent vacancy rate and a 1.7 percent rent rise. The retail sector is expected to exceed 10.3 million square feet this year. Retail availability will likely decline to 11.0 percent for the year, and rent will rise 0.8 percent.
The apartment rental market continues to be the standout in the commercial sector. Net absorption is expected to reach 219,318 units this year, driving the vacancy rate to 4.3 percent (from 5.2% in 2011). Rent is projected to rise 4.1 percent this year and an additional 4.4 percent in 2013.
The second quarter data shows a general slowdown in commercial real estate, following broader economic trends. With a presidential election around the corner and legislative milestones awaiting in January, we are looking at a stormy second half of the year.