Sunday, April 27, 2008

CRE Bust: How Deep, How Fast?

by Bill McBride on 4/27/2008 01:14:00 PM

A key historical investment pattern is for non-residential investment in structures to follow residential investment by about 4 to 7 quarters (both up and down). See Investment Matters for some graphs on this subject.

Clearly the CRE slump is here. Now the questions is how deep and how fast will CRE investment fall. One way to think about this is to look at previous declines in non-residential investment.

non-residential structure investment Click on graph for larger image.

This graph shows non-residential investment in structures as a percent of GDP since 1960. Over time there has been a decline in spending (as a percent of GDP), probably related to globalization (more factories were being built overseas).

The non-residential investment boom related to the S&L crisis is obvious on the graph, and we should probably ignore that period when looking at a typical CRE bust.

The two light green circles show the investment busts during the '90/'91 and '01 recessions.

The decline in non-residential investment was fairly rapid during the previous two recessions (a decline in non-residential investment is usually more rapid than a decline in residential investment). In fact most of the decline in investment happened within four quarters.

During the '90/'91 investment slowdown, non-residential investment declined 17% in total, and about 14% in the first year. For the '01 investment slowdown, non-residential investment declined almost 20%, and 19% in the first four quarters.

It is very possible - based on tighter lending standards (see graph 3 in Investment Matters) - that the decline in non-residential investment will be greater (on a percentage basis) than the previous two busts. However, based on commercial vacancy rates, it doesn't appear that some segments of commercial are as overbuilt as in the '90/'91 and '01 periods.

These two factors somewhat balance out, and my guess - based on these two previous busts - is that non-residential investment will decline about 15% to 20% over the next four quarters, from a $501 billion seasonally adjusted annual rate (SAAR) in Q4 2007, to about $400 billion to $425 billion in Q4 2008 - and that most of the bust will happen during 2008.