Do GDP Gains Signal Rate Hike?

By Chris Nebenzahl and Justin Dean

The United States economy grew at its fastest rate in two years with real gross domestic product (GDP) annualized growth of 2.9 percent, according to the Bureau of Economic Analysis. This solid growth is positive news for the commercial real estate sector. Gains in personal consumption, exports, private inventories and federal government drove  growth in the quarter.

The solid GDP growth in conjunction with a tightening labor market has experts anticipating the Fed to raise interest rates in December. However, the increase will likely be in the range of 25-50 basis points which would not greatly affect cap rates for property owners. The spread between cap rates and treasury yields should remain near historic highs despite a minor increase in the Fed funds rate.

Income rises, consumption decreases slightly

Two thirds of total GDP is consumer spending, which increased at a modest 2.1% in the third quarter, less than half of the 4.3% gain in the prior quarter. Despite the slowdown, steady consumption growth bodes well for both retail and industrial real estate, as e-commerce continues to accelerate.

Supporting the increased consumption was disposable personal income which grew 3.6% in the third quarter following 4.1% growth in the second quarter. While income is not growing quite as quickly as rents, the increased wealth should allow multifamily fundamentals to remain strong. On the other hand, personal saving also ticked up in the third quarter indicating that Americans may be eyeing home purchases in the future.

Single-family vs. multifamily investment

Residential fixed investment (RFI) remained relatively flat, decreasing $700 million to $695.5 billion, and RFI as a percent of GDP ticked down slightly in the third quarter. When evaluated as a share of GDP, RFI bottomed out at a historic low in the third quarter of 2010 at 2.4%. Although its share of GDP has steadily recovered in the last five years, it still remains well below the long term average of 4.7%. Going back to 1947 when the BEA began tracking RFI, the only time that its share of GDP was lower than its current 3.7%, is in the middle of economic downturns.

Digging into the RFI numbers confirm the historic multifamily supply growth that has occurred in response to the robust rent increases of the last half-decade.  Multifamily fixed investment increased to $61.1 billion, a 2.2% increase from the second quarter and a 13.6% increase over the third quarter of last year. These numbers echo the significant supply growth occurring in much of the country. Yardi Matrix identifies 650,000 multifamily units currently under construction nationally, of which 365,000 are forecasted to deliver in 2017 after roughly 350,000 will be delivered in 2016 by year end.

With the multifamily construction boom likely to continue into 2018, developers may be glad to see that single family investment, at $236.7 billion, continued its downward trend for the year. This reflects a 2.0% decline from the second quarter and a 1.3% decline on a year-over-year basis. A slowdown in single family investment suggests that demand for multifamily should remain high as first-time homebuyers will face a tight market for homes.

Exports Up

Another key factor supporting third quarter GDP growth, was the 10% increase in exports, the largest gain in roughly three years. While this may appear on its face to be great news for those in the industrial sector, a substantial portion of the export growth is the result of a onetime boost to soy bean exports that occurred due to a poor crop yield in South America.  Zooming out to the macro economy, the robust export numbers hint that the overall trend provides positive support that the dollar strength is moderating.

At a time when many believe that we are nearing the end of the current cycle and commercial real estate investors stress that a long-term view is essential, a solid quarter of growth should be received warmly.