Overall, we remain confident that consumers will continue to increase spending at a healthy clip, which will boost the need for both retail and industrial space int he coming year.
- Anxiety about consumer spending is misplaced. Revised retail sales data indicate that consumer spending in the U.S. is rising steadily.
- Consumers are feeling better about current conditions in the economy and their finances. Historically, when the current conditions index is high, consumer spending growth is healthy.
- One concern about spending is wage growth, which remains sluggish, but there are signs that wage increases are going to accelerate.
- Overall, we remain confident that consumers will continue to increase spending at a healthy clip, which will boost the need for both retail and industrial space in the coming year.
Over the past few weeks, there has been a lot of hand wringing about the U.S. consumer. Last month, the Commerce Department reported that in July U.S. consumer spending fell 0.2% (adjusted for inflation). Since consumers represent two-thirds of U.S. gross domestic product, a decline in spending was seen as a sign that growth may be stalling – as it has several times during this recovery.
This week, the first estimate of U.S. retail sales for August was released and with it revised data for June and July. Retail sales rose a healthy 0.6% in August, the largest increase since April, as strong auto sales boosted spending. Perhaps more importantly, the level of retail sales in both June and July was revised upward. The 0.2% increase in June was revised to a 0.4% gain and the unchanged reading in July was revised to a 0.3% increase. Retail sales represent about half of total consumer spending (the other half is spending on services), so the upward revision means that spending most likely did not decline in July as first reported.
Ever since the severe winter, consumer spending has been on a roll. In January, U.S. retail sales declined 0.9%, the largest decline since June 2012, as people had trouble getting out of their houses due to the series of “polar vortexes” which blanketed much of the country in freezing conditions. It was no surprise when retail sales bounced back in February (+0.9%) and again in March (+1.5%), but spending has remained strong even after the rebound. In fact, since January, U.S. retail sales have increased at an annual rate of 8.4%. Inflation over this period was about 2.3%, so real spending has been rising at a very healthy 6.0% clip since January.
Other economic data support the view that consumers are likely to continue to increase spending at a strong pace in the coming months.
Optimism is increasing. The Thomson-Reuters/University of Michigan Index of Consumer Sentiment continues to improve. In early September, the Index rose to 84.1, the highest level since July 2013. The “Current Conditions” component of the Index, which reflects consumer feelings about their current financial condition, decreased very slightly but remains near multi-year highs. The current conditions index tracks very closely with consumer spending, so a high reading means households are more likely to increase spending in the coming months.
Debt is well managed. According to the Federal Reserve, household debt service payments as a percent of after-tax income are at the lowest level since the Fed began measuring this back in 1980.
Income is rising. Real after-tax income in July 2014 was up 2.6% from a year ago. That’s not a spectacular gain, but it is the largest increase since October 2012 (excluding the tax driven jump in late 2012). The pace of income growth has been steadily improving. In the first seven months of 2014, real after-tax income increased at a 4.0% annual rate.
Wages are a concern. To be sure, part of the reason for the increase in income is a result of more people working. Average earnings of workers have been growing more slowly. In the second quarter of 2014, wages as reported in the Employment Cost Index were up only 1.9% from a year earlier. The increase in wages has remained between 1.5% and 2.0% for the past five years, barely keeping pace with inflation. To see sustained strong growth in consumer spending, wages need to increase at a faster pace. We think that is likely to occur.
But there are signs of future growth. Surveys of businesses indicate that it is getting harder to find qualified employees and as a result, they are raising compensation. In its monthly report on small businesses released this week, the National Federation of Independent Businesses noted that the percentage of firms with at least one position that is hard to fill climbed to the highest level since 2007. When it is hard to find employees, businesses are generally forced to raise wages. Another component of the index showed that the percentage of firms raising compensation is back to 2006/2007 levels. So even though wage growth has been slow, it appears that the tightening of labor markets and difficulty finding qualified workers is starting to have an impact. This is why we anticipate that wage growth will accelerate in the coming year.
About a month ago, we wrote “The Consumer is Ready to Carry the Load”. That now appears to be happening.
This is all very positive for commercial real estate.
- Stronger consumer spending will boost demand in the economy and lead to more hiring in many industries. More jobs mean more demand for space. Office demand is likely to increase.
- As consumer spending increases, it means more shopping in stores. As noted above, real retail sales are up at a roughly 6.0% annual rate since January. This is likely to lead to more demand for retail space.
- More spending means more shopping online. The latest retail sales data indicate that online purchases now account for 24% of the sales of the combined online sales plus general, apparel, furniture and other (GAFO). Five years ago they accounted for 18% and 10 years ago 13%. As more shopping is moving online, the demand for industrial space will only increase.
- The healthy financial state of households will also lead to more spending on leisure activities. Consumer spending on food services and accommodations increased 2.5% in the last four quarters and that includes a steep weather-driven decline in the first quarter. We expect that healthy growth will continue in the coming year leading to greater demand for hotel rooms and a stronger hotel sector.
- Last, but certainly not least, the multifamily sector will benefit as improving general economic conditions lead to more household formations.
When consumer spending rises, everyone benefits. Click the image below for the full report.