The State of the Economy, The Consumer, and The Effects on Multifamily Investments
2021 is now well underway and as we head into the first anniversary of the COVID-19 pandemic, we at Arcan think that this is a good time to reflect on the state of the economy and what we think the near-term future holds. Hard as it is to believe today, most people had not heard of COVID-19 at this time last year. When the pandemic did strike the U.S., most of us thought that it would be short-term economic blip and we would all go back to normal within a few weeks at most. Clearly, this would not be the case. Only now, however, can we start to see some of the economic trends that have emerged. Many are not what we imagined them to be when the virus first hit.
In addition to looking at economic data in the aggregate, we believe that informed investors will also pay close attention to the performance of distinct sectors, regions, and consumers. Perhaps the most interesting dynamic is that of the consumer. While we have written on the burgeoning stratification of workers previously (see discussion on that topic in our prior post), the American consumer remains, generally, in good shape. This is somewhat surprising given the historic job losses over the past year, but it does reflect a potential for strong growth once the virus is under control.
For multifamily assets specifically, the continuing stratification of workers will play a meaningful role in determining which properties perform well and which do not. We continue to see Class C assets struggling with collections and rent growth. These properties tend to cater to tenants who work in retail, hospitality, and other public-facing jobs. However, many consumers who live in Class A and Class B properties are actually sitting on substantially more cash reserves than pre-pandemic. This bodes very well not only for overall near-term economic performance, but it indicates that most will continue to pay their rent and it could lead to increasing rents as well.
2020 GDP and Where We Are Today
In the spring of 2020, most observers predicted a sharp economic contraction followed by either a “V”, “U”, or “L”-shaped recovery. The road back has been more complicated (i). The economy contracted sharply in Q2, followed by a significant “snap-back” in Q3 and strong growth in Q4. Q4 growth could arguably have been stronger, but many states and localities reimposed lockdowns of their economies in November and December (ii). End of 2020 Nominal GDP was $21.48 trillion compared to $21.74 trillion at the end of 2019 (iii). Thus, the economy has regained much of its losses, but it has not yet reached its 2019 high. The pace of growth has also slowed considerably, though this was to be expected. Moreover, while GDP growth did bounce back to a large degree, major stratifications opened between sectors and different types of workers. Restaurants, for example, continue to struggle mightily while many tech firms are reporting record profits (iv).
As we head further into 2021 and beyond, we expect the pace of economic growth to subside and return to recent historic averages in the 2-3% range. This is barring any unforeseen negative externalities related to the virus, such as a vaccine-resistant variant emerging. Unfortunately, the virus does remain a major risk factor and will continue to do so until far more of the population is inoculated. Given the recent ramp-up in vaccinations, however, we are hopeful that the economy will continue to emerge from lockdowns and resemble its pre-pandemic form by the end of 2021, if not sooner. The reduction in COVID-19 cases and hospitalizations should lead to increased consumer confidence and continued economic growth in 2021 and 2022.
Longer term, there are increasing worries about the federal debt-GDP ratio as well as individual firms overleveraging on cheap debt. However, with interest rates likely to stay at or near their current levels until at least 2023, these concerns may remain muted. Arcan believes, however, that these longer-term risk factors must be considered when looking at multifamily investment opportunities, particularly as this monetary stimulus substantially raises the risk of inflation.
The State of Today’s Consumer
One of the most interesting developments over the past year has been the incredible degree to which Americans are saving their money. The personal savings rate surged to unprecedented highs in 2020, with over $1.4 trillion saved in the first nine months of the year alone (v). This amount was double the total savings over the same period in 2019. While the savings rate has come down substantially off its highs from the spring, it remains elevated relative to its historical average. Americans are sitting on vast sums of saved money, much of which is expected to be spent later this year as the COVID-19 situation is brought under control.
The savings rate has remained elevated for a variety of reasons, including the effect of consumer perceptions of safety as well as government lockdowns. Consumers have shunned certain types of businesses and most states and municipalities have either closed bars, restaurants and music venues wholesale or severely limited their capacity. Spending at these businesses has declined precipitously during the pandemic. While much of this spending has shifted to goods, consumers have saved more than in prior periods.
An additional factor in the increase in the savings rate is fiscal stimulus from the U.S. government. As of February 22, 2021, Congress has passed two distinct rounds of fiscal stimulus directed at the consumer. While the policy merits of such stimulus can be debated, there is no question that many Americans have used this additional cash to either save or pay down debt, presumably leaving them in better fiscal health. As the pandemic is brought under control and the service sectors of the economy begin to re-open, the consumer is surprisingly very healthy.
Effect on Multifamily
Overall, consumer spending represents roughly 2/3 of U.S. economic output, thus the increasingly sunny consumer outlook bodes very well for the economy and is one of the primary reasons the fourth quarter of 2020 was so strong. Indeed, Q1 GDP projections have increased sharply as economists factor in the surprising strength of the American consumer. The Atlanta Fed, for example, revised its Q1 GDP forecast from 4.5% growth to 9.5% growth within the span of a week (vi). As the pandemic subsides, we are likely to see a surge in demand for certain goods and services, specifically those tied to hospitality. In turn, this should prompt additional hiring in these sectors and continue the cycle of growth.
Multifamily stands to benefit greatly from the strength of the consumer. The increase in the savings rate and the renewed economic growth could potentially translate to higher rents in the near to medium term. Many cities, particularly those in dense, heavily-taxed states have seen outflow of population and corresponding rent decreases during the pandemic. Conversely, cities both large and small in the Sunbelt have generally experienced population growth and rising rents as well. This trend is likely to continue post-pandemic, though rents are likely to bounce back in gateway cities such as New York and San Francisco.
Arcan focuses exclusively on the Southeast, thus we are increasingly confident that well-located properties in our region will not only continue to outperform those in other regions, but the pent-up demand and increase in consumer savings could lead some renters to look for more premium product in the next few years. As such, we think that there may be some additional market rent increases in select markets. However, as monetary stimulus continues to inflate asset values, the need to be a strategic investor is ever more important as the turnaround in pricing can always come sooner than expected. And while most consumers are in excellent shape today, inflation can quickly erode any savings power they may have attained over the past year.
(i) “This is how the global economy will recover from COVID-19, according to CEOs”. September 22, 2020. World Economic Forum. “https://www.weforum.org/agenda/2020/09/covid19-recovery-shape-economy-ceo/
(ii) Grace Hauck and Chris Woodyward “New Coronavirus Restrictions: Here’s What Your State Is Doing To Combat Rising Cases and Deaths. November 13, 2020. USA Today https://www.usatoday.com/story/news/nation/2020/11/13/covid-restrictions-state-list-orders-lockdowns/3761230001/
(iii) Economic Indicators. Moody’s Analytics. https://www.economy.com/united-states/nominal-gross-domestic-product
(iv) Annie Palmer. “Amazon reports first $100 billion quarter following holiday and pandemic shopping surge”. February 2, 2021. CNBC. https://www.cnbc.com/2021/02/02/amazon-amzn-earnings-q4-2020.html
(v) Josh Mitchell. U.S. Household Income, Savings Rose at End of Last Year. January 29, 2021. The Wall Street Journal. https://www.wsj.com/articles/consumer-spending-personal-income-coronavirus-december-2020-11611873351
(vi) Federal Reserve Bank of Atlanta. GDPNow. https://www.frbatlanta.org/cqer/research/gdpnow