DTZ Economic Forecast June 2015

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U.S. Macro ForecastJune 2015

U.S. Macro Forecast: Still Lots of Runway

• First quarter blues are behind us, U.S. economy accelerates from here.

• Fed is likely to begin raising rates in September, but global forces will keep long-term rates low.

• Demand for CRE is strong and is setting records in most CBDs.

• Despite global risks, lots of runway is left in the expansion.

A majority of the recent remarks on the state of the U.S. economy appear, at best, to reflect ambivalence about growth prospects. That ambivalence is primarily due to a few unexpected curveballs: a weakened global economy, a plunge in energy investment, a soaring U.S. dollar and another tough winter, all of which certainly took their toll on growth. Through the first three months of the year, real GDP growth was again weak—indeed so weak that the previous estimate of first-quarter growth was revised downward from 0.25% to -0.75%. This has been such a pronounced post-recession trend—weak first-quarter figures followed by solid growth in the remaining three quarters—that the U.S. Department of Commerce is actually revisiting how it calculates seasonal factors, which

may be missing important features of the economy’s performance during the winter months.

But even though year-end 2014 and first-quarter 2015 presented more than a few obstacles, there is still significant evidence that the underlying strength of the U.S. economy remains intact. Despite all of these hurdles, real GDP still managed to grow 2.7% year-over-year as of the first quarter of 2015, a growth rate high enough to sustain commercial real estate demand drivers. One of the most significant headwinds to GDP growth in the first part of the year came from the nose-dive in energy-related investments. We estimate that the fall in oil prices shaved at least 50 basis points (bps) off top-line GDP growth in the first quarter of this year. Thus far, there has been little to no evidence that the plunge in oil and gas prices is stimulating increased consumer spending. This will soon change.

The U.S. consumer has been ultra-conservative so far this year, a behavior that makes little sense from an economic standpoint. Personal consumption expenditures grew by a meager 1.8% annualized rate in the first quarter compared to the fourth quarter’s 4.4% rate. Meanwhile, the personal savings rate soared from 4.6% in November of last year to 5.0% this April. In other words, consumers are choosing to

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First Quarter BluesReal GDP, % Change Annualized

Source: U.S. Bureau of Economic Analysis

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Personal Savings, %

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Consumers Saving for a Warmer Day Consumers Are Saving for a Warmer Day

Source: Census Bureau

June 2015

By Kevin J. Thorpe, Chief Economist, & Rebecca Rockey, Economist

Click to view U.S. Macro Forecast

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Job Creation Rolling 12-month Job Gains/Losses

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15-year High

Source: U.S. Bureau of Labor Statistics

Job CreationRolling 12-month Job Gains/Losses


hold on to any extra savings from the gas pump rather than spend them, but this behavior will prove to be temporary. It is important to note that if there was a looming economic slowdown, consumers would typically react by cutting down on unnecessary items. That is not happening. Consumption at restaurants and hotels continues to be strong, posting a 5.3% annualized growth rate in the first quarter of 2015. Spending on foreign travel was up 20% year-over-year from the first quarter of 2014. Sales of durable goods, led by auto sales and spending on car parts, are strong no matter how you look at the data. These are clear, tell-tale signs indicating that the consumer is feeling just fine and that the weakness in other spending data was mostly weather-related. With the weather warming up and with extra spending money in the pockets of all automobile drivers, consumer spending will rebound materially as will economic growth.

Look no further than the labor markets to identify numerous signals telling us that both consumers and employers are feeling confident. Between May 2014 and May 2015 there were more than 3 million new nonfarm payroll jobs created, and the unemployment rate declined significantly to 5.5%, from 6.2%. For 10 consecutive quarters, year-over-year growth in total nonfarm employment has exceeded 2%, meaning that the strong job growth that is currently occurring has actually persisted for nearly one year, despite a rising dollar value and falling oil prices. So far this year, nearly 30% of new jobs were in office-using sectors, with a bulk of those

in professional and technical services, and 8.3% of new jobs created were classified as part of the industrial sector.

Not only is annual job creation higher than it’s been in the last 15 years, but job openings now total over 5.4 million – the highest number on record. If one were able to give each unemployed individual one of these jobs, the U.S. would have an unemployment rate of 2.2% today (the lowest dating back to 1948 when recording keeping began). Although this is purely theoretical, it does give a sense of how robust the labor markets have become. In addition, the quit rate is steadily increasing to pre-recession levels. It is currently just under 2.0% versus 2.2% in the first half of 2007. A larger number of people voluntarily quitting jobs signals that there is widespread confidence in the ability to secure another job. It is against this backdrop that we anticipate increased tightening in most employment metrics.

We would be remiss in our labor market analysis if we did not discuss what is happening to the underemployed. The broadest measure of underemployment—which includes workers who are discouraged, marginally attached to the labor force or who are working part-time for economic reasons (also called the “U6”)—fell 130 bps from 12.1% in May 2014 to 10.8% in May 2015. Of the three groups, the number of discouraged and marginally attached workers has actually remained relatively level—not such good news. However, the number of people working part-time for economic reasons has declined by nearly 1 million—that is

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Oil & Gas Prices

Source: U.S. Energy Information Administration, Oil Price Information Service

5.4M jobs

Gas prices are still 27% lower than a year-ago.

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good news. By analyzing the data on the flows in the labor market, one can actually track the number of people who shift from one employment status to another. In the past 12 months ending in May, 1.9 million more unemployed people entered the labor force than left it. Additionally, 3 million more workers became employed than became unemployed. While these figures do not erase the sobering fact that there still are many who are considered “underemployed,” it does illustrate that significant gains have been made. Nominally, the number of these people seems large, but the underemployment rates are actually at or below their long-

term averages. These will be some of the most important figures to watch as the Federal Reserve considers its first interest rate hike.

Falling oil prices, an appreciating U.S. dollar and low inflation have been hallmarks of the past year. They have remained some of the greatest challenges for the Federal Reserve to consider as it discusses monetary policy normalization. The consensus forecast, mildly reflected in the tone of the latest FOMC minutes (released in May), calls for the first rate hike to take place this September. In our baseline forecast, we, too, anticipate the first rate increase will occur in September. This assumes that both oil prices and the U.S. dollar are stable—or at least pose no significant threat to the broader economy—and that core inflation is nearing the Fed’s target rate of 2%. It also assumes that the Fed will be cautious in its actions. Small 25 bps increases are likely to be the approach until there are clear signs that the global economy can handle more aggressive tightening.

Despite the rising odds of Fed action, long-term interest rates will remain extremely low. The 10-year Treasury bond yield has abruptly increased in recent weeks, from 1.9% at the end of April to 2.4% in early June. While the sharp increase is a bit worrisome, it is likely to be a blip driven by the jittery financial markets. Indeed, we saw similar jumps in the 10-year yield when the Fed ended its quantitative easing Underemployment

Labor Market Flows (000s of Persons)


April 2015

Employed to Unemployed 1,805

Not in the Labor Force to Unemployed 2,319

Unemployed to Not in the Labor Force 2,008

Employed to Not in the Labor Force 4,394

Not in the Labor Force to Employed 4,388

Unemployed to Employed 1,996

Current # Long-term Average #

Current Share of Labor Force

Long-term Average Share of Labor Force

Discouraged 472,000 479,000 0.3% 0.3%

Marginally Attached 1,0732,000 1,583,000 0.8% 1.1%

Part-time For Economic Reasons 8,346,000 6,939,000 4.2% 4.7%

Total Under-Employed 10,550,000 9,001,000 5.3% 6.0%

311,000 more unemployed people entered the

labor force than left it in May 2015. Add that up over

the past 12 months, and you’ll have 1.7 million

more people entering than exiting.

8.3% industrial

29% o�ce-using

11.1% leisure & hospitality

22.3% healthcare

10.3% construction

Share of Job Growth By Industry, 2015 YTD

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programs, and those increases were not sustained. Long-term interest rates are driven primarily by future inflation expectations. There is very little inflation in the world economy (if anything it is closer to disinflation), and global inflation is expected to remain low for quite some time. In our baseline forecast, we estimate the U.S. 10-year bond yield will average 2.2% in 2015 and then gradually push upwards in 2016 to average 2.6%.

Despite some quirks to start the year, the fundamental drivers for the U.S. commercial real estate markets remain solid. While we watch economic developments closely, we also note that it takes significant time for most economic

movements to filter through the CRE markets. The most important drivers of CRE demand are doing just fine.

CRE’s Positive Momentum Demand for commercial real estate is strong and in some sectors setting new records. Nearly every city in the U.S. is experiencing extremely robust trends in the multifamily sector. In fact, nearly half of the country has a multifamily vacancy rate below 5%, and there is a lengthy list of markets—both large and small—that have a vacancy rate below 3%. While the multifamily sector has maintained the lead throughout the current expansion, there are signs that the construction pipeline will temper some of its allure. Deliveries are expected to peak this year with just over 230,000 new units coming online, according to Reis. The U.S. apartment sector has been absorbing 176,000 new apartment units per year since 2010, so even if this level of demand is sustained going forward, new supply will exceed it. Add almost another 200,000 units planned to be delivered in 2016, and the vacancy rate is expected to register around 5% by 2016, up from the current 4.2%. That being said, apartment demand will remain robust. Bear in mind that the three largest single-age cohorts are still in their early 20s. These young adults are considered prime candidates for apartment rentals. The demographics will remain favorable for rental demand at least for the next several years. As it stands, rents will continue to increase despite the rise in vacancy but at a decelerating rate.

The industrial sector is also booming. Industrial product had its strongest year on record in 2014, and in the first quarter of this year 38.8 million square feet (msf) of space already has been absorbed. Vacancy was 7.6% in the first quarter of this year—a cyclical low—and rents have been aggressively pushing upwards in multiple markets. There are few signs of abatement. A rising dollar has led to fewer exports but more imports which also go through ports and other intermodal hubs. Although manufacturing product faces more challenges from the greenback’s appreciation, it also benefits from the recent uptick in automobile and auto parts sales. As of the first quarter this year, auto sales have been above 17 million (an annualized rate) for three consecutive quarters for the first time since 2005.

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Federal Funds Rate Post-Recession Rate Paths

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Source: Federal Reserve Board

Federal Funds RatePost-Recession Rate Paths, %


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U.S. Dollar Yr/Yr % Change in Dollar Value

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The industrial sector also is benefitting immensely from the ever-growing e-commerce industry. Retail sales excluding automobiles were up barely 1% year-over-year in the first quarter, while e-commerce sales were up 14.5%. Now estimated to have accounted for nearly 55% of industrial absorption over the past three years, e-commerce is still going strong. E-commerce now accounts for 7.2% of total retail sales and is on track to double that share by 2020.

There is little evidence to suggest these strong industrial trends won’t continue. We forecast that the U.S. industrial sector will absorb 179 msf in 2015. The absorption will once again exceed new development, causing vacancy to fall to 7.1% by year end.

The office sector continued to gain momentum in 2014. Net absorption hit its highest point this cycle with 74.1 msf of demand, up 37% from the year before. Given the underlying trends in office-using employment—which posted gains of 315,000 jobs in the first five months of this year—we estimate that net absorption of office space will accelerate by an additional 10% in 2015.

One headwind that continues to work against the office sector is space efficiency. Not only are we seeing the number of square feet (sf) occupied per worker fall—now slightly below 175 sf/worker—but we are also seeing declines in gross leasing. In each cycle, gross leasing activity as a share of inventory has fallen from 2.6% (before the

2001 recession) to 2.1% (before the 2007 recession) to 1.6% (the current cycle). However, it will be net absorption that pushes vacancy rates down—towards the 14% mark by the end of the year—which in turn, will place upward pressure on rental rates.

Year-over-year rental rate growth was 2.3% in the first quarter of this year. The spread between Class A and Class B rents is falling fast—now averaging $6/sf. This is due primarily to faster rent growth in Class B space (particularly in CBDs), despite the fact that Class A still accounts for a majority of total net absorption. We anticipate further acceleration in rent growth, driven increasingly by CBD Class B space, throughout 2015.

It’s hard to draw any one theme about the retail sector as there is no one trend that can correctly characterize all of the different types of space. Overall, highly visible Class A space is performing very well with vacancy rates below 5% in nearly every primary and secondary market. Meanwhile, lower-quality space continues to face severe challenges. More than 75% of vacant shopping center space is in Class B and C segments—mostly Class C. Demand for new retail space is soaring, and developers are responding. New deliveries in 2014 were almost at 2005 levels, 23.7 msf vs. 25.5 msf, and speculative development is on the rise.

E-commerce continues to take its toll on certain bricks-and-mortar stores, dampening the overall absorption figure

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Office Asking Rents Gross, $/PSF

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E-Commerce Demand Industrial Net Absorption

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E-commerce accounted for

51% of demand in 2014.

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to about half of what we observed before the recession. Nevertheless, vacancy is slowly tightening across community and neighborhood centers, power centers and high-quality malls. Assuming consumer spending shifts into higher gear as we expect, the retail recovery will gain momentum. Mid-price point retailers will continue to struggle, but growth in high-end and low-end retail will more than offset the weakness in the middle.

Resilience and ExpansionThe biggest threats to the U.S. economic expansion are from overseas. Globally, the picture is messy. Emerging markets are still struggling. Due primarily to slumping commodity prices, Brazil’s economy has now entered into a recession. Russia’s economy has also entered into a recession, primarily due to the plunge in oil prices. China’s economy is struggling. The recent metrics on housing construction, trade and manufacturing have all decreased. Growth in the Eurozone remains anemic, and all eyes are once again on Greece. The odds of a Greece/Eurozone breakup have never been greater. Tensions between Russia and Ukraine are looming. The European Central Bank (ECB), the Bank of Japan (BOJ) and other central banks are engaged in quantitative easing, while the Fed considers its first interest rate hike in years. It is unclear how global financial markets will react to the possible shift in monetary policy, so there is plenty to keep us up at night.

But the U.S. economy has demonstrated resiliency against many of these headwinds, and there is clear evidence forming that it is already shaking off its “first-quarter blues.” In fact, the U.S. economy has overcome a succession of negative scenarios throughout the recovery, bouncing back with greater momentum after each temporary obstacle. The longest expansion post-World War II was the 10-year growth cycle that spanned from 1990 to 2000. Midway through 2015 and six years into the current expansion, there is little evidence to suggest that this expansion can’t last longer. From a commercial real estate perspective, the odds are heavily in favor of continued expansion with a lot of runway left.

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Global Forces Will Keep the 10-Yr Treasury Low CPI, % change yr ago

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Germany Middle East and Africa Asia Spain Japan Italy Euro Zone

Source: Moody’s Analytics

Global Forces Will Keep the 10-Yr Treasury LowCPI, Yr/Yr % Change

Source: Moody’s Analytics

BrazilRecession

Deep Recession

Risk of deflation

Struggling Economy

Russia

Eurozone

China

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U.S. Macro Forecast Table

U.S. Research • Kevin Thorpe, Chief Economist • Rebecca Rockey, Economist • Tel: +1 202 463 2100

(a) - Annualized Growth Rate, Quarter-over-Quarter (b) - Thousands, SA, Quarterly Chg. (c) - Millions square feet (d) - Quarterly Sum, Billions **CoStar Group & Real Capital Analytics historical data; DTZ forecasts

About DTZDTZ is a global leader in commercial real estate services providing occupiers, tenants and investors around the world with a full spectrum of property solutions. The company’s core capabilities include agency leasing, tenant representation, corporate and global occupier services, property management, facilities management, facility services, capital markets, investment and asset management, valuation, research, consulting, and project and development management. DTZ provides property management for 1.9 billion square feet, or 171 million square meters, and facilities management for 1.3 billion square feet, or 124 million square meters. The company completed $63 billion in transaction volume globally in 2014 on behalf of institutional, corporate, government and private clients. Headquartered in Chicago, DTZ has more than 28,000 employees who operate across more than 260 offices in 50 countries and represent the company’s culture of excellence, client advocacy, integrity and collaboration.

DTZ announced an agreement to merge with Cushman & Wakefield in a May 11 press release. The new company, which will operate under the Cushman & Wakefield brand, will have revenues over $5.5 billion, over 43,000 employees and will manage more than 4 billion square feet globally on behalf of institutional, corporate and private clients. The agreement is subject to customary closing conditions and is expected to close before the end of 2015. For further information, visit: www.dtz.com or follow us on Twitter @DTZ.

2014 2015 2016 Annual

Q3 Q4 Q1 Q2 Q3 Q4 Q1 2014 2015 2016

US EconomyReal GDP, % 5.0 2.9 -0.8 2.6 4.1 3.9 3.3 2.4 2.5 3.0

Nonfarm Employment, ths. 744 850 767 621 681 727 879 2,629 2,963 2,499

Office-using Employment, ths. 230 230 203 160 181 217 244 700 803 727

Unemployment Rate 6.1 5.7 5.6 5.5 5.3 5.2 5.1 6.2 5.4 5.1

Retail Sales & Food Services, % 3.2 1.9 -4.8 4.1 6.0 7.2 4.4 3.9 -4.6 5.4

CPI Inflation, % 1.2 -0.9 -3.1 1.3 1.2 1.7 2.0 1.6 -0.6 1.9

CCI 91 93 101 96 102 108 105 87 102 107

Fed Funds Rate 0.1 0.1 0.1 0.1 0.3 0.5 0.8 0.1 0.3 1.5

10-year Gov't Bond 2.5 2.3 2.0 2.1 2.2 2.3 2.5 2.5 2.2 2.6

ISM Manufacturing Index 56.9 56.9 52.6 52.5 53.3 52.7 51.3 55.7 52.8 54.0

West Texas Intermediate 98 73 49 57 61 64 68 93 59 69

Office SectorNet Absorption, msf 22.4 22.8 11.4 23.7 21.4 21.8 10.8 71.3 78.3 82.5

Vacancy 14.8% 14.5% 14.4% 14.2% 14.1% 14.0% 13.9% 14.9% 14.2% 13.5%

Asking Rents $22.39 $22.52 $22.68 $22.87 $23.08 $23.31 $23.57 $22.35 $22.99 $23.56

Industrial SectorNet Absorption, msf 40.9 51.4 38.8 40.2 48.9 51.1 37.6 162.5 179 156

Vacancy 7.9% 7.7% 7.6% 7.5% 7.3% 7.1% 7.0% 8.0% 7.4% 6.8%

Asking Rents $5.22 $5.28 $5.35 $5.42 $5.52 $5.61 $5.71 $5.21 $5.48 $5.76

Retail SectorNet Absorption, msf 20.3 24.5 30.1 18.4 26.2 21.7 20.3 94.6 96.4 87.1

Vacancy 6.5% 6.3% 6.1% 5.9% 6.0% 6.0% 6.1% 6.4% 6.0% 6.2%

Asking Rents $15.45 $15.50 $15.55 $15.59 $15.64 $15.70 $15.73 $15.44 $15.62 $15.75

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DTZ Economic Forecast June 2015