Drama-Free Budget Deal Provides Welcome Policy Certainty for Real Estate Investors
CoStar Analysis: Proposed Budget Deal Expected to Reinforce Business and Consumer Confidence
JULY 25, 2019|ABBY CORBETT
In a dash to reach a resolution before recess, congressional leaders announced they have agreed on a federal budget deal this week.
The bipartisan budget agreement moderately increases discretionary spending budget caps throughout the next two fiscal years, 2020 and 2021, and also suspends the federal debt ceiling through July 2021. The Senate is positioned to approve the deal during the final days of its session, which ends Aug. 2.
Assuming the current deal is backed by both chambers and signed into law, the deal eliminates the risk of a debt-ceiling standoff early this fall and ensures that the U.S. government will be funded come September.
While the risks associated with a debt-ceiling standoff and government shutdown fight are worth mentioning, the last government shutdown had a minimal impact on commercial real estate.
Avoiding Another Shutdown
The most recent shutdown marked the longest in U.S. history and persisted 36 days; most government shutdowns were shorter and lasted a matter of weeks. The prior 21 shutdowns since 1976 averaged eight days. Under those circumstances, and depending on the severity and length of the shutdown, economists typically downgrade gross domestic product 10 to 20 points per week. Yet, subsequent quarters following a resolution typically witness a rebound helping to make up any lost ground.
Oxford Economics estimated the previous shutdown imposed a 20-point drag on GDP in the first quarter of 2019, or 1.8% annualized.
Beyond direct impacts on those furloughed and forfeiting pay, a broad government shutdown diminishes consumer sentiment, which acts as a drag on consumer spending and has the potential to erode retail sales figures. The consumer sector and sentiment are impacted in the short term, yet the impacts to commercial real estate have been minimal — at least thus far.
Businesses often pause long-term investment decisions as business sentiment takes a hit and loan sources are restricted, yet those negative consequences have also been short-lived; this dynamic was proven throughout the first quarter, when we saw a rebound in both consumer sentiment and National Federation of Independent Business’ “Small Business Optimism.”
Reduced leasing activity on the part of both retail and industrial tenants could be a longer-term consequence of diminished spending throughout the consumer sector and reduced business investment. However, that outcome has not arisen in the past, at least not at the national level.
Markets such as Washington, D.C., which have a high concentration of government employment, would certainly feel the shifts in employment whereby government employees potentially seek opportunity in the private sector and the government leases are unwound. It would take time, however, for these dynamics to reverberate to office leasing fundamentals.
From a capital markets standpoint, transaction volume and pricing have not historically registered a measurable adverse reaction to budgetary and debt-ceiling standoffs, as investors tend to believe in an eventual resolve. At the local level, in D.C. for example, uncertainty might weigh more heavily on investment decisions, particularly for value-add or development deals that involve the careful timing of construction and lease-up assumptions. However, investor concern has not previously manifested in measurable volume declines.
Shorter-term impacts of a government shutdown are also felt throughout the residential and multifamily real estate sectors. Furloughs of government employees at federal agencies including the Federal Housing Authority, part of the Department of Housing and Urban Development, and the Department of Agriculture reduces mortgage availability and delays approvals for new loans spanning the single-family, multifamily and public housing segments. A more protracted government shutdown would have a more pronounced impact on the transaction volumes for these segments.
Seeking Certainty, Less Turmoil
Ever-hungry for good news to celebrate, financial market participants have welcomed Congress and the White House’s sprint to reach an agreement, particularly amid the political polarization plaguing the legislature. The Dow Jones industrial average and S&P 500 both opened 0.3% higher on Tuesday following Monday’s deal.
But, apart from the comforting news of knowing the government won’t run out of cash before Congress returns from its recess, how would this agreement change the near-term outlook for economic growth? Not much.
Wells Fargo Economics, for example, says this week’s agreement was already incorporated into its existing economic forecast. Assuming the agreement becomes law, revised economic outlooks will remain harmonized with current economic forecasts. The current budget agreement increases the top-line limit per law, but only modestly increases inflation-adjusted current spending.
The agreement would not only avert a full government shutdown this fall, but could also reduce political turmoil and policy uncertainty leading into the second half of the year. Policy uncertainty erodes economic momentum, slows business decisions and weighs on the sentiments of federal employees. Reduced policy uncertainty can support the trajectory of the current economic environment and will, at the very least, not lead to tangible adverse effects on the economy.
Don’t Celebrate Too Soon
While the media is touting this deal as a victory, and while both chambers of Congress appear to support the bill, leadership on either side of the aisle could still back out. President Trump could also reverse course at the last minute. Moreover, even if the agreement on the debt ceiling and discretionary spending limits is made before both chambers take their recess, budget appropriations must still be made to determine how these funds are to be allocated across governmental programs.
The most recent prolonged government shutdown, from December 2018 through January 2019, arose due to appropriation disagreements, not headline discretionary spending limits. With such a politically heated and divided Congress, ongoing appropriation fights are possible once Congress returns this fall. Financial market celebration might very well be premature and fleeting.
Once Congress returns to session and appropriation debates resume, ongoing policy turbulence is likely. Another shutdown would cloud the U.S. economic outlook and result in a downgrade to short-term growth, marked by dampened consumer and business sentiments.
Historically though, the loss in confidence felt by businesses, consumers and investors has not derailed the economy. History also suggests that shutdowns have had a negligible effect on equity markets. While not diminishing the economic ramifications of this policy uncertainty, the illiquid nature of commercial real estate, coupled with its longer-term lease structures, helps to insulate it from the strife of short-term government impasse.
Abby Corbett is a managing director and senior economist for CoStar Market Analytics in Chicago.
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Article by CoStar