The Consumer Has Cash

The U.S. unemployment rate is now experiencing its 8th consecutive quarter below 4%, with national unemployment clocking in at 3.9% as Q4 of 2023 begins. Historically speaking, a phenomenon like this occurs about twice every century. Practically speaking, this means that the U.S. consumer has cash.

Much attention has been focused on inflation and the Fed’s policy of interest rate increases over the past year. Generationally high inflation has not simply triggered an increase in the cost of borrowing money, but also brought about soaring construction and materials costs, labor costs and other related costs of doing business in the commercial real estate industry. Collectively, these frictions in the marketplace conspired throughout Q2 and Q3 to slow or stall numerous commercial real estate transactions in markets across the U.S. For better or for worse, these challenging dynamics are the ones that have captured headlines for over a year.

But in spite of the various headwinds the market has encountered throughout 2023, an economy near full employment has proven to be a powerful tonic that neither inflation nor climbing interest rates could dampen. A multi-year period of sub 4% unemployment has not occurred in the U.S. since 1966-1969 (See Chart). This is truly historic data, and an under-reported, poorly understood economic jolt that continues to propel the U.S. economy, even as the Fed has labored to slow it down.

The consecutive challenges of the COVID pandemic and the subsequent spike in interest rates that aimed to combat inflation, greatly reduced the pipeline of new commercial real estate developments in recent years, even in the services arena of retail shopping and dining. Despite the shrunken pipeline of new inventory, the sales increases of essential brands in the quick service (QSR) and fast casual restaurant space, warehouse clubs, grocers, and fuel/C-stores continue to out-perform users across virtually every sector of the commercial real estate industry. Increasing average unit volumes (AUVs) by drive-thru and fast casual users, strongly supplemented by increasing adaptation of online ordering that was learned during the pandemic, have users that sell everything from coffee to chicken to burgers to fuel all scrambling to add unit count.

Consequently, a collision is now taking place in markets nationally in which expanding brands with great credit and a big appetite to meet consumer demand are in heated competition for a limited supply of new retail inventory that is only slowly making its way through the development/entitlement pipeline. This dynamic is presently on full display in the Northern California market, where our firm is bringing multiple new projects to market and consistently encountering multiple offers and overbids on rent for new high quality retail projects. On a single proposed new development that our team is currently pre-leasing, we recently received offers from five national coffee brands alone. Brands like these are flush with business because the U.S. consumer if flush with cash, triggering a fist fight for new, high-quality real estate opportunities as they come to market.

The fully employed U.S. employment market is the engine driving strong sales in the essential retail & dining space, even as other CRE segments, notably office buildings, struggle to reconcile the paradigm shift to work-from-home.

During the early and middle parts of 2023, the factor that was more impactful than the rising costs of doing business, was the uncertainty around how much higher the Fed would have to push interest rates to tame inflation. This uncertainty pushed many would-be users to the sidelines, pausing growth to wait out the impacts of increasing capital market pressure on their businesses.

But the recent flattening of interest rates and cooling of inflation have brightened the market outlook in Q4, removing uncertainty about what’s next, thus enabling those users that had hit the pause button to re-engage in lease and purchase transactions. Consequently, the playing field has quickly become crowded with high-credit retail and dining brands, creating an opportunity for landlords to craft favorable real estate deals that will pay dividends for years to come.

Industry watchers have observed for the past few years that the COVID pandemic and its aftermath would create an overhauled lineup of winners and losers in the US economy. As 2023 comes to a close, the vastly different fortunes in the retail and office segments of the commercial real estate industry provide a vivid illustration of how that transformation has played out.