The longest economic expansion in U.S. history continues to churn out more output and job additions with each passing month. November 2019 marks 125 consecutive months of growth and the momentum factors hint at the trend continuing into at least spring of 2020. Then what? A recession? Not likely, except for one policy error.
Though the populace is intensely polarized politically, as related to the economy, U.S. consumers are indicating high conﬁdence. The consumer conﬁdence index was 125 in September, well above the 100 neutral mark seen throughout 2019. For reference, the index has been under 100 for nearly a decade starting from 2007. The solid expression of conﬁdence about the economy is without a doubt due to the very low unemployment rate of 2.7%, an all-time high in total household wealth in the country as the stock market boomed, and record high real estate values. The prior peak in the net worth of all households was $70 trillion in 2007 right before the last recession, sunk to $60 trillion at the depths of the foreclosure crisis, and then rose to $113 trillion as of mid-2019. Quite an incredible feat, though we should be reminded that wealth holdings have become much more concentrated at the top. All this could mean good things for the land market outlook in 2020.
Consumers consequently are opening up their wallets. Consumer spending rose 2.6% in the second quarter of 2019, after adjusting for inﬂation, and has been the prime engine for GDP growth over the past few years. Spending on consumer durable goods – with a long product life span – has been even stronger at 4.4%, attesting to the longer- term positive assessment of the direction of the economy. There is no over-borrowing to fuel personal consumption. Finances are coming from an employment growth of 2.15 million net new jobs, rising wages from $27.30 per hour to $28.09 over one year, and higher wealth by a few trillion dollars. Miraculously, there are more job openings today (7 million in August 2019) than the number of unemployed (5.7 million workers).
However, there is not as happy a story for businesses. Corporate proﬁts are indeed very high, especially after cuts to the corporate tax rates a few years ago, rising from $1 trillion in 2008 to nearly $2 trillion now.
This partly justiﬁes why the stock market is near record highs. But even with healthy ﬁnancial conditions, companies have been less aggressive in spending the cash for machinery, factory expansion, and other investments.
Business investment spending contracted in the second quarter of 2019. Spending on equipment barely changed, but spending on commercial building fell by 4.7% from a year ago. Though assuring no oversupply of commercial real estate construction, the fact that businesses are pulling back is concerning and raising the question as to why.
The timing of businesses getting cautious is directly related to the raising of tariffs and hostile rhetoric towards international trade. In fact, many companies in their public statements during quarterly earnings calls say they are cautious because of uncertainty related to trade prospects. REALTORS® specializing in commercial real estate have witnessed that trend as leasing activity markedly slowed in the second quarter to only 3.1% growth compared to better than 10% gains in 2016 and 2017, and 5% gains in 2018. Moreover, even business travel has weakened, as evidenced by falling occupancy rates at hotels, which is now at 72.4%, a full 100 basis points lower than from a year earlier.
The most troubling aspect is the actual slowdown in global trade. U.S. exports fell 1.7% recently while U.S. imports grew by only 2.6%. When both exports and imports decline for a few straight quarters, then a recession is near certain with job cuts. In a growing economy, both exports and imports should be rising by at least 5% per year. This slowdown in trade has had repercussions elsewhere. Just about every notable economy is experiencing slower economic activity in 2019 compared to recent prior years. The International Monetary Fund (IMF) cut its global growth estimate to 3.2% for 2019 after having forecasted 3.6% earlier in the year. The economies of the world appear to move in sync, like a rising tide lifting most boats — and the movement reverses when trade restrictions are put in place. The stock market has nearly always cheered at the promise of a trade agreement and sunk following the rhetoric of a trade war and retaliations of more tariffs. More positively, it is becoming clear that both the U.S. and China are looking for a deal. In such a case, business spending could boom.
One promising sector that could help with future economic growth is real estate construction. America is facing an acute housing shortage – for both single- family owner occupancy and for multifamily apartments. Home prices and rents have been rising far in excess of wage growth for ﬁve straight years.
Vacancy rates are at historic lows. The underproduction of new homes over the past decade has cumulatively resulted in around ﬁve to six million housing units that are needed today. Even in a normal year, only around 1.5 million new homes can be constructed. Therefore, increased construction needs to occur for multiple years. In 2020, speciﬁcally, housing supply is expected to improve, with housing starts expected to hit 1.4 to 1.5 million, up from 1.275 million in 2019.
With home builders still likely to be constrained by what they call the 5Ls — labor, land (lots), lending (ﬁnancing), lumber (raw materials), and restrictive laws (regulation) — housing starts will still not match the demand from household formation (1.2 million), or the replacements for demolished or obsolete housing (about 450,000). All that means more demand for land and lots.
“…more demand for land and lots.”
In the commercial market space, industrial properties have outperformed retail spaces, arising from the stronger growth in online shopping and quick distribution warehouse needs. Investors are paying much more for industrial ﬂex/warehouse properties on account of low rental vacancy rates and the sustained demand for e-commerce sales. Given that warehouses can be built in off- center sites far away from downtowns and population centers, the demand for land will grow in outlying regions.
In the meantime, the interest rates will be at near historically favorable conditions. The Federal Reserve will more likely cut its fed funds rate a notch in 2020 rather than increasing. It just means that 10- year Treasury yields will remain low at around 1.6% and the longer term borrowing rate at under 4%. In future years, watch what happens to the federal deﬁcit, which is expected to be near $1 trillion in 2019 and projected to surpass $1 trillion in 2020. The total federal debt level, adding of all past deﬁcits, will reach 100% of GDP in a few years, well above the 60% that many economists consider as manageable.
The bottom line summary is that while the economy is experiencing the longest running growth period in U.S. history, there is no reason why it has to falter. The economy is expected to ﬁnish 2019 with only moderate growth of 2% due to soft business spending activity, after having notched up a solid 2.9% in 2018. For 2020, a recession is not in the cards, but this assumes some type of truce in the trade war. A trade agreement will be better still and will lift business spending.
“…expect continued job creation, income growth, and rising demand for land.”
Construction spending has to rise to relieve housing shortages and low vacancy rates in commercial real estate. Therefore, expect continued job creation, income growth, and rising demand for land.
About the author: Dr. Lawrence Yun is chief economist and senior vice president of Research at the National Association of REALTORS®. He directs research activity for the association and regularly provides commentary on real estate market trends for its 1.4 million REALTOR® members.