The Real Estate Industry Should not Get Too Excited About 4Q09 GDP Growth

Hey, don’t get me wrong. We should be happy that GDP is growing after what we have been through during the past couple of years. We certainly should take it as it is preferable to well below trend growth. The big questions are: Is this growth sustainable? and, How will the employment picture be affected?

In order to answer these questions, let’s take a look at the components of our 4Q09 economic expansion.

The broadest measure of economic activity, Gross Domestic Product, grew at an annual rate of 5.7% in the fourth quarter of 2009 after growing at just 2.2% in the third quarter. This growth was the fastest for the U.S. economy since the third quarter of 2003 when it expanded at a rate of 6.9%. (Even after 4Q09 growth, GDP remains 1.9% below its peak 2008 levels) Overall, 2009’s GDP finished with the biggest contraction since 1946 when the country was still reeling from World War II. In 2009, GDP fell by a total of 2.4%.

Our economy has been able to grow without seeing jobs grow as employers have been getting more production out of fewer workers. The most recent data available is from 3Q09 where we saw that productivity grew at a robust rate of  8.1 percent. While positive from the perspective that productivity growth is always a precursor to economic recovery, the real estate industry needs job growth in order for our fundamentals to turn positive.

The dominant factor in fourth quarter growth was not consumer spending but was instead inventory related. Nearly 60% of GDP growth came from a temporary factor – the sharp slowdown in inventory slashing by American businesses. Inventories contributed 3.4% of the 5.7% expansion. It is interesting how fluctuations in inventories impact how GDP growth is calculated. You would think that in a robust economy, goods would be selling so fast that inventories would get depleted at a fast rate and that fast rate of inventory reduction would indicate the economy is healthy.

It is actually the opposite. In a healthy economy, inventory reductions are met with increased production which keeps inventories at relatively high levels. During a downturn, production is not initiated which causes inventory levels to shrink. The destocking of inventories in the fourth quarter slowed to the point where substantially more of final demand had to be satisfied by new production. Using this method of counting, even if destocking slows to zero in 1Q10, inventories will make a positive contribution to GDP growth.

The sharp decrease in inventory slashing, from $139.2 billion in 3Q09 to a much more modest $33.5 billion in 4Q09, also reflects a desire by businesses to be ready for increased demand and a recognition that they may have cut production too aggressively during the downturn.

(As we know, GDP figures are subject to revision and often these revisions are substantial. For instance, 3Q09 GDP growth was originally announced at 3.5%, was revised down to 2.7% and was finally revised to 2.2%. We expect another downward revision, in March, to the 4Q09 figures as inventories are such a big component and the real estate industry has seen industrial vacancy rates growing substantially and rapidly. If production was keeping pace at the rate projected, we find it hard to believe industrial (warehouse) vacancies would be at their presently growing and high levels.)

These inventory changes alone cannot sustain growth over an extended period of time. 70% of our output is consumer based and, thus far, final sales to consumers and businesses have been disappointing. Consumer spending in 3Q09 was 2.8% which fell to 2% during 4Q09. While the fourth quarter increase was more than expected due to the expiration of the cash-for-clunkers program which stimulated auto sales, in the past consumption has been a much larger driver of growth after a recession. Weak consumption figures are a reminder that 10% unemployment is causing Americans to hold back. This is the main reason why the Fed has no short term plans to reverse its highly accommodative monetary policy.

Perhaps the most promising aspect of last Friday’s report was the pickup in equipment and software spending. Businesses increased their investment in these areas at an annualized rate of 13.3 % in 4Q09 as compared with only 1.5% in 3Q09. Pent-up demand could be  a significant contributor to this gain.

Exports also grew nearly twice as fast as imports indicating that international trade increases, aided by a weak dollar, added to GDP growth as well.

But let’s look at consumers and jobs as these have the biggest impact on our commercial real estate markets.

The Labor Department announced Friday that wages and salaries of non-government workers rose at a seasonally adjusted rate of 0.5% in 4Q09. This was the largest increase in over a year, but was very weak by historic standards. Separately, consumer sentiment on the Reuters/ University of Michigan index rose to 74.4 for January, up from 72.5 in December. This is up from last February’s low of 56.3. While this reflects increased confidence among American households, confidence levels are still significantly below levels seen prior to the recession’s start in December 2007.

As I have said over and over again on StreetWise, commercial real estate needs jobs for our recovery to be tangible. It is upsetting to think that the Economic Policy Institute in Washington projects that even if our 5.7% GDP growth rate were to be sustained for three years, we would still not create enough jobs to climb out of the hole caused by this recession. Moreover, most economist project that GDP growth will moderate during the rest of 2010 with a more likely 2.0% to 2.5% total growth for the year. The fourth quarter spike reveals how deeply businesses emptied their shelves last year but gives no indication that they are confident in bringing back workers or hiring new ones.

There are presently two schools of thought on what the recovery will look like. The first is the “V – School” which says that production, employment and durable goods spending, which falls to excessively low levels will see activity bounce back just as strong as the pendulum swings back to compensate for the fall.

The second is the “U School” which says that the recover is more dependent upon the nature of the recession and not its depth. It says that there is no reason to expect that an asset bubble bursting that pushes spending down from unsustainable levels must give way to a strong recovery ( think 1991 and 2001).

Final demand appears to be tracking sluggishly towards the U.

In order for the recovery to be sustainable, businesses will have to start investing again and at a much faster rate than the 2.9% 4Q09 result which remains relatively weak for this juncture in a recovery. And for that to happen we need a resurgence of greed over fear and a revival of corporate animal spirits. Anti-business rhetoric coming out of Washington does little to rekindle this spirit.

Washington is now the main obstacle to a durable and sustainable expansion. Real job creation, which commercial real estate so desperately needs, will not be catalyzed by politically directed credit (by virtue of taking the big-bank tax and giving it to community banks to lend to small business) or government spending but from business investment and new-business creation.

It is difficult to imagine this happening with the uncertainty surrounding future taxes. If the government came out with a definitive tax landscape (related to the pending Bush tax cut sunset and other short-to-medium-term tax levels) and a believable plan for dealing with massive budget deficits, employers might start hiring again. And that would create real growth in our industry.

Forecast GDP growth of 2% to 2.5% for 2010 is hardly making anyone feel good. How it actually plays out is anyone’s guess and here are the potential deviations: To the upside, sharp easing of financial conditions could stimulate consumption and/or capital spending more than expected; To the downside, the effort needed to overcome the removal of unprecedented fiscal stimulus from the economy may be greater than anticipated. We could also suffer from any policy errors the Fed makes as it attempts to exit the market.

Our message to Washington should be, keep the TALF, keep the PPIP, keep everything but give us JOBS. Focusing on that a year ago would have been nice.

Mr. Knakal is the Chairman and Founding Partner of Massey Knakal Realty Services in New York City and has brokered the sale of over 1,050 properties in his career.

3 Responses to “The Real Estate Industry Should not Get Too Excited About 4Q09 GDP Growth”

  1. 1 JM February 1, 2010 at 9:27 am

    “If you don’t spend your money, I shall spend it for you”

    Uncle Sam

  2. 2 Chris February 4, 2010 at 11:54 am

    Mr. Knakal,

    Very nice piece. I think the recovery will be between a V and U where the recovery starts out like a V but then the incline moderates around the middle of 2011 as the low hanging fruit of growth no longer exists. Does it make sense what I am describing in terms of the shape? I wish I could draw it out on here!



  3. 3 terrig February 5, 2010 at 11:45 am

    Jobs aren’t created in DC. Real economic growth doesn’t come from Washington. It comes from small business owners. “Job creation tax credits” don’t create jobs.

    No business owner I know decides to hire based on tax credits. This is inane, only a bureaucrat with no/little business experience, which describes most of our legislators & their staffs & the government workers thinks a “credit” will cause people to change their plans.

    Let’s simplify the tax code & regulatory environment. American know-how (before we forget-how) will help solve the rest.

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