Get Ready for CRE’s ‘New Normal’

According to economist Hugh Kelly, there are reasons to believe the U.S. economy is already shifting into "an altered state that will require significant adjustments to conventional expectations for commercial property."

Earworms come unbidden and then stubbornly inhabit our awareness, sometimes as subtle background music and at other times intruding on our consciousness and insistently demanding attention. With the millions of melodies inhabiting what we might call the phonosphere, there seems to be a song that suits any topic or occasion. As we turn our focus toward the 2020s, it is “Ebb Tide” (written by Carl Sigman and Robert Maxwell in 1953 but peaking as a hit for the Righteous Brothers in 1965) that is ringing in my ears.


Hugh Kelly, PhD., Economist
Hugh Kelly, PhD., CRE 

In previous columns, we’ve noted the dramatically slower economy for 2020–2029 that is the base case in Congressional Budget Office projections. That forecast calls for a decade of sub-2 percent GDP growth and average monthly job gains under 50,000 persisting until 2030. As I’ve argued previously, the real risks—notwithstanding short-term expectations of a cyclical downturn—are that a post-recession “new normal” will differ from our experiences of all previous cyclical recoveries and expansions, and that the probability of a decade-long demand retrenchment has not been priced into asset markets, neither in corporate equities nor in real estate.

There are structural reasons to suspect that the U.S. economy is already morphing into an altered state that will require significant adjustments to conventional expectations for commercial property. As we’ve noted since our contributions to Commercial Property Executive began in 2013, it does begin with demographics. Researchers at Bain & Co. have noted that the U.S. labor force, which grew at 1.2 to 1.3 percent in the 1990s and the first decade of this century, decelerated to 0.7 percent growth in the 2010s, and will be slipping yet again to 0.3–0.4 percent in the 2020s and 2030s.

America is not alone in this deceleration; population-fueled growth in the large Asian economies (China and India) has likely peaked, while Europe and Japan are already in labor-force shrinkage. Worldwide trends, therefore, are unlikely to provide an external economic boost to U.S. domestic growth.

Unsustainable High

As we’ve expected, third-quarter U.S. GDP growth dipped below 2 percent in the Commerce Department’s advance report, released on Oct. 30th. The fiscal policy-induced growth spurt of 2018 proved as unsustainable as we feared, once the sugar high of tax cuts and deficit spending during expansion were metabolized by the system – and then eliminated by natural economic processes. Now—and even more alarmingly—the Federal Reserve has entered into a round of monetary stimulus even as moderate growth still prevails in the economy. That raises a worrisome question: What fiscal and monetary policy moves remain, should an actual downturn come upon us?

Elementary macroeconomics teaches that there is a fairly simple formula for gross domestic product: C+I+G+(x-m), that is, GDP is composed of consumption, investment, government Spending, and the trade balance (the difference between exports and imports).  Here, too, a structural examination suggests some fundamental and difficult-to-alter conditions predicting slow demand growth for real estate, as well as other economic sectors, in the 2020s.

In this column, let’s take a look at consumption (the “C” in the formula), and examine other factors in future commentaries.

Personal consumption expenditures, while positive into 2019, have been decelerating since a cyclical peak in 2014. The lag in wage and salary growth, compared with the tightening of the labor market and income from financial instruments, means that the majority of U.S. consumers still find disposable personal income squeezed. The Bureau of Economic Analysis actually shows the steepest rise in third-quarter income coming from the farm sector, where the usual level of agricultural subsidies were ballooned by the “tariff rebates” directed by the administration to mitigate losses caused by the ongoing trade war. 

It is in the consumer sector—where employee compensation accounts for 61.5 percent of personal income—that the impact of a widening income inequality gap magnifies the demand effects of the wage and salary lag. Why is this the case? Lower-income households have a significantly higher marginal propensity to consume—in economics, the principle that an additional dollar earned is likely to be spent on goods and services—compared with wealthier households.

This means that there is a great multiplier effect when incomes rise in the bottom tiers of the economy. But research has shown that the farther down the income scale a worker falls, the less likely that they are keeping up economically. Most of the gains have, for decades, been captured by the top of the income distribution, which has a higher “marginal propensity to save.”

When Disparity Met Clarity

The impact of this disparity was displayed by the partial federal government shutdown of late 2018 and early 2019. The situation offered an example of what economists refer to as a natural experiment, one shaped by random circumstances rather than by researchers. Deprived of a couple of paychecks, government workers scrambled to find resources to meet rent and mortgage payments, and looked to charitable food banks to feed their families. And these were workers with putatively secure, middle-class jobs.

The “experiment” confirmed estimates by the Federal Reserve that 40 percent of American adults cannot meet a $400 emergency expense. By a wide margin, such straitened circumstances pose a more fundamental threat to the retail real estate sector than the much-discussed impact of E-commerce.

Even casual observers of the American economy are often aware that consumption accounts for 70 percent of GDP. This is not just spending at the stores (or on-line). Some 64 percent of personal consumption is directed to services, among them health-care, food services, housing, financial services (including insurance), and recreation (including the hospitality sector).

Thus the constriction of income growth in households with the highest marginal propensity to spend has its own negative ripple effects on a variety of real estate demand sources, residential and commercial. Property industry executives have a stake in narrowing the income inequality gap, a stake that is simply their own self-interest. Otherwise the economic tide will be ebbing even more dramatically than we have seen to this date.

Hugh F. Kelly is director of graduate programs & chair of the executive advisory council curriculum committee at the Fordham University Real Estate Institute, and chair of the institute’s executive advisory council curriculum committee. He is a principal at Hugh F. Kelly Real Estate Economics, a consultancy. Kelly is the author, most recently, of 24-Hour Cities: Real Investment Performance, Not Just Promises (Routledge/Taylor & Francis).

Read the December 2019 issue of CPE.