January 27, 2017
- Executive Summary: Gross Domestic Product (GDP) for Q1 2017 grew by 0.7% at an annualized rate, falling below consensus opinion of 1.1% and below Q1 2016’s 0.8% growth. This was the slowest quarterly growth since Q1 2014, when GDP shrank.
- Don’t Be Alarmed: Q1 has been the weakest quarter in five of the past eight years and two of the past three. There is much debate among economists about the seasonal adjustment factor used in the GDP calculation, and how to discount one-off events such as unusually warm winters. Furthermore, the Atlanta Fed’s “Nowcast” has predicted this result for several months and, as such, the market had no immediate reaction to the announcement.
- Fed Watch: The Fed will not be overly concerned about this slowdown, as its focus has shifted to inflation. Core PCE inflation accelerated to the Fed’s target of 2% from 1.3% in the previous quarter. The Fed is still expected to raise interest rates twice more in 2017. The chance of a rate increase in June is still very likely despite weak GDP growth in Q1. In addition to raising rates, the Fed has signaled that it will unwind its balance sheet in the near future. This will impact the long end of the curve much more than the federal funds rate. The Fed is unlikely to begin action until late 2017 or early 2018, but how it plans to engage in that policy change will likely be communicated this summer.
- Drop in “Trump Bump”: After a run-up following the Trump inauguration, 10-year Treasury yields have settled at 2.3% currently as the market started to discount forecast growth. That is down from 2.6% in March. The bond market is signaling that its optimism is waning due to the slower-than-expected policy roll-outs of the Trump administration and the failure to pass healthcare reform. Passing meaningful tax reform will be critical to sustaining optimism.
- Tax Reform: The plan announced earlier this week by Treasury Secretary Steven Mnuchin had few surprises, including lower individual and corporate taxes (corporate from 35% to 15%) and the elimination of most deductions except for mortgage interest and charitable donations. The plan is short on details and did not mention a border tax, the prospect of which is of particular concern to retailers. There also was no detail on whether the mortgage interest deduction might be limited to single-family housing and whether depreciation of capital expenditures will be accelerated. Finally, the proposed elimination of state and local tax deductions will be strongly opposed by those states most affected by it (NY, NJ, CA, MD).
- Interest Rate Impact on CRE: Higher interest rates expected throughout the year will put more pressure on cap rates. If the administration and Congress adopt tax reform and an infrastructure program that are truly expansive to the economy, then tenant demand could increase to offset potentially rising cap rates.
- Diversified Growth: The increase in real GDP in Q1 reflected positive contributions from non-residential fixed investment, exports, residential fixed investment and personal consumption expenditures (PCE).
- Capital Investment: Equipment investment increased at a 9.1% annualized rate, while investment in non-residential structures decreased by 22.1%.
- Consumer Firepower: Though personal consumption expenditures grew much slower in Q1, personal income rose faster than in Q4 and the savings rate increased. Consumers can increase their spending without stressing their balance sheets going forward.
- Single-Family Strength: Residential investment increased by 13.7%, following a strong Q4. The housing market is picking up with new and existing home sales increasing in Q1.
- Businesses Turn Cautious: The deceleration in real GDP in Q1 reflected a deceleration in personal consumption expenditures and downturns in private inventory investment. Businesses are clearly worried. They are shrinking inventories as consumption stalls.
- Personal Consumption: PCE growth was 0.3% after rising 3.5% in Q4. Despite sentiment indexes indicating otherwise, consumers have taken a step back with their spending. What they are saying and what they are doing are two different things. Durable goods spending fell by 2.5%, its biggest drop in four years.
- CRE Conclusions
- Retail: Despite strong balance sheets and consumer confidence readings, consumers slowed their spending, though some of this is due to weather-related factors (warm weather in Q1 meant less home heating oil and related consumption). Strong wage growth and healthier balance sheets could help later in the year.
- Office: Job growth averaged 180,000 a month in Q1, the same pace as 2016. This is likely to slow due to the tight labor market. Many businesses are leasing more space after holding off during the latter part of 2016. This may slow if “Trump Bump” optimism wanes and the job market remains tight.
- Industrial: 2017 got off to a strong start and that is likely to continue as e-commerce gains market share at the expense of retail. Trade is a growing concern among our foreign trade partners and the IMF has been vocal in its concern over “protectionism.” This could significantly disrupt the industrial market, especially coastal markets with port exposure.
- Multifamily: Overbuilding of Class A towers is weighing heavily on the top end of the market. This will trickle down, but the gap between Class A and Class B is still large. Rent growth is still occurring for Class B and C apartments and for markets that haven’t been overbuilt. Rent growth and a tight labor market will help demand for this sector.
Spencer G. Levy | Head of Research
CBRE | Americas Research
T 617 912 5236
[email protected] | LinkedIn | Twitter
Jeff Havsy | Chief Economist | Managing Director
CBRE | Americas Research | Econometric Advisors
T 617 912 5204
[email protected] | LinkedIn | Twitter