Ever since I attended college and started paying attention to economics, it has been a constant mantra on the news that consumer spending made up roughly two-thirds of the Gross Domestic Product or GDP. The other one-third was comprised of business investment. Since it has been divided that way ever since I can recall, I assumed that it was just the way it was and should be. But along the way, we started to get some warning bells going off.
In 2006, the U.S. was showing a negative savings rate of 1 percent, which was the largest negative savings rate since the Great Depression in 1933 when it was negative 1.5 percent. In fact, in 2006 it had been negative for 21 consecutive months. During these boom years, people viewed their rising stock and home values as a de facto savings account that was doing the savings for them, i.e. all gain with no pain of having to actually save money out of their incomes. This allowed consumers to shift more money into spending so that by 2007, consumer spending was making up about 71 percent of GDP.
Then came declines in the housing markets. It first started with the subprime loans turning bad but eventually spread to housing value declines across all sectors and in most markets. In our local economy, the median home price for Washoe County now sits at $182,000 as of June. That is off the high-water mark of $325,000 set in October of 2005, or a 44 percent decline. Using this median home value as a metric does not necessarily indicate that everyone's home in Washoe County has come down in value by 44 percent, but we know that we have taken substantial hits on our values.
The housing declines were followed by a precipitous drop in the stock market. After hitting a high of 14,164 on October 9, 2007, the stock market declined 55 percent by the time it reached the low set on March 9, 2009, at 6,440. Even after rising 44 percent off the lows, the Dow Jones Industrial Stock Index in early August 2009 is still off over 34 percent from its high set in on October 2007.
With a current decline in the stock market of 34 percent and a 44 percent decline in the median home price, local consumers are now seeing a major decline in values for their two largest asset classes. Consumers can no longer save by watching their stocks and home values rise. They actually have to save money from their incomes, which is exactly what they are doing.
The latest national figures show that the savings rate increased to 6.9 percent of income. This is by far the largest amount consumers have socked away for some time. Compared to a 1 percent negative savings rate in 2006, this is a total swing of 7.9 percent coming out of consumer spending.
Another factor impacting consumer spending is the level of unemployment and underemployment. The national unemployment rate currently stands at 9.5 percent, while Washoe County has an 11.8 percent unemployment rate and rising. There are also a large number of underemployed people working at part-time jobs even though they would like full-time employment. One report I recently read indicated that Washoe County could have a figure closer to 21 percent including unemployed, underemployed and people who have quit looking for jobs. While unemployed and underemployed consumer spending does not drop to zero, their discretionary spending is largely limited and has a negative impact on overall consumer spending.
The effects of the decline in home value can be divided into two camps. One is the overall "wealth effect," and the other is the lack of availability of home equity loans available to homeowners now. A 2007 study by the Congressional Budget Office titled Housing Wealth and Consumer Spending made an attempt to quantify these two issues. The report showed that home equity withdrawals peaked in late 2004 and 2005 at nearly $900 billion per year. They estimated that one quarter or $225 billion of that home equity withdrawal was used for consumer spending. The report also indicated that at the height, the home equity withdrawals comprised slightly over 10 percent of personal disposable income. For many consumers, the equity in their homes has been decimated and many banks have either ratcheted down or withdrew lines of credit for home equity loans to borrowers. The loss of home equity lines of credit is another factor that will detract from overall consumer spending.
In addition to the retrenchment in the home equity lines of credit, credit card companies have also began to scale back credit limits for borrowers they consider a credit risk, further reducing consumer spending.
All of these factors have led to a "perfect storm" for the consumer. Loss of wealth in their stock portfolio and homes, loss or fear of job loss, and less available credit has led consumers to increasing their savings rate substantially. All of these factors impact the consumer's ability to continue their spending at the peak levels set in 2007 and 2008. The question now is, "How much of an impact will this have on consumer spending going forward?"
This is where I need to make my disclosure. I'm a commercial real estate broker, not a full fledged economist. The following is my attempt to quantify this question the best I can after contemplating it for several months. So, here it goes.
If I add a 7.9 percent swing in savings, estimate 6 percent reduction from home equity loans, 2 percent reduction for unemployment and underemployment, and maybe 2 percent for reduction in stock prices and reduction in credit card spending limits, I come up with an estimate of 18 percent. Let's say I underestimated the resilience of the consumer and/or the duration of prolonged unemployment and we add back 3 percent. We still have a reduction in consumer spending around 15 percent.
I think that would be a reasonable working estimate of what we should expect to see in regard to the reduction in consumer spending for the near future.
One question I have remains: What impact will this reduction in spending have on the amount of shopping center space needed to serve the consumer? I would say there will be a proportionate share of retail space that will be vacated and remain vacant until we see a resurgence in consumer spending. Perhaps it will be a bit less given the remaining retailers will probably suffer with reduced sales per square foot as well. Let's say one-third of the loss is shared with the existing tenants with lowered sales and two-thirds results in store closing. That would indicate a vacancy rate increase of 10 percent.
Interestingly, our overall vacancy rate has increased from 6 percent in 2005 to 15.64 percent today. That's almost a 10 percent increase in the vacancy rate. That seems to jibe pretty well.
Believe me, I know there is a lot of margin for shifting these estimates around. That is why I've had a challenge framing these estimates in my own mind for the last several months. But maybe, just maybe, we are getting close to the bottom in the occupancy levels within our local retail real estate market.
Kelly Bland is senior vice president in the retail properties group of NAI Alliance. Contact him at 336-4662 or email: kbland@naialliance.com.
