Will Taco Bell predict the next real estate crash?

Discretionary income is a leading economic indicator

Glen Weinberg //July 28, 2016//

Will Taco Bell predict the next real estate crash?

Discretionary income is a leading economic indicator

Glen Weinberg //July 28, 2016//

What does a fast food restaurant like Taco Bell have to do with real estate? Can the sales of Taco Bell predict the next crash? What do sales at fast food restaurants mean for the general economy?

According to Bloomberg economist Richard Yamarone, “Restaurants are the ultimate consumer discretionary purchase and can be a leading economic indicator.” Across the industry, same-store sales growth has decreased for the past three months, according to MillerPulse data and traffic has also declined every month for the past year.

Historically, sales at fast food restaurants have a strong correlation with general economy which means as one metric moves the other metric typically moves in tangent. This leads to the question, with sales declining at fast food restaurants is this an indicator for the rest of the economy?

First, let’s define discretionary income. This is basically “money to spend” after all the critical/required items are paid out of a person/family’s budget. For example, this is money that is “left over” after paying taxes, mortgage, car, daycare, insurance etc. — basically, all the necessities.

Why is discretionary income important? The US economy is powered largely by consumer spending. This means when the economy enters a recession or is not performing well consumer discretionary income basically dries up. This correlates directly to business profitability.

Discretionary income is also a leading metric in loan decisions by banks. A typical bank will look at your income “left over” after paying your primary expenses to gauge how much to lend to you. For example, they will look at your discretionary income to evaluate if you can buy that new car or if they should increase the balance on your credit card.

When consumer’s pull back on discretionary income companies that sell necessities do well while companies focused on discretionary income purchases like restaurants perform poorly. This consumer pattern has occurred in every major cycle in history, including our last downturn. What does this mean?

Fast food restaurant purchases are the “ultimate consumer discretionary purchase” and therefore an important metric for the general economy. The recent analysis showing same store sale decreasing and traffic also decreasing over the past year means that consumer discretionary income has likely peaked. Historically this could be the very early stages of another cycle.

Basically if consumer spending pulls back with discretionary purchases, the consumer could be flashing a warning sign to the general economy.  Either the consumer has less discretionary income or they are being cautious with their discretionary income due to economic uncertainty.

First, does the consumer have less discretionary income? This could be a primary reason for the pull back in sales at fast food restaurants. One of the largest expenses in a family budget is housing. Housing throughout the country has gone up substantially, especially in places like Denver. Wage growth is not keeping up with the large growth in housing expenses which in turn decreases the amount of discretionary income.

In Denver, according to the Denver Business Journal rents increased by almost 10 percent in 2015. This is following large increases in rents for the prior years. Unfortunately, the average wage growth according to a Denver post article is expected to be only about 2.8 percent. This is a large disconnect and correlates directly to consumer spending in Denver. There is no doubt that the discretionary income budget has been cut substantially as housing gobbles up a larger percentage of income.

The second reason for discretionary pullback could be consumer confidence. Consumer confidence appears to have peaked around January of 2015 according to a recent report by the St. Louis Federal Reserve. As consumers become less confident in the future, they pare back on discretionary purchases. This could also explain why discretionary income purchases at fast food establishments has declines as well.

Regardless of the primary driver for the decline in discretionary purchases, this does not bode well for the general economy and ultimately real estate. As mentioned above, consumer spending is one of the largest drivers of the economy. Over time, the pullback in discretionary income will impact the overall health of the economy.

So what does this mean for real estate? Less discretionary income will have major impacts on real estate as well. First, discretionary income typically tracks consumer confidence. As consumer confidence erodes people’s willingness/desire to purchase property also erodes. Along with consumer confidence, discretionary income changes (loss, decrease, etc.) will impact bank underwriting and therefore the ability to get loans.

Finally, as prices continue to appreciate, discretionary income is not keeping up with the large price increases. The large run up in prices makes it even harder for people to purchase properties because they need a higher down payment and more discretionary income to for repayment.

Will Taco Bell predict the next downturn in real estate?  Unfortunately, based on Taco Bell’s sales trends, it looks like the taco is half-eaten. This will no doubt impact real estate prices through discretionary income (or lack thereof) down the road.