MORGAN STANLEY: This corner of the real estate market is about to peak

Non-residential construction spending is set to peak in the third quarter, according to Morgan Stanley economists.

In a client note on Monday, Ellen Zentner, chief US economist, wrote that the bank’s Non-Resi Permits Index fell 1.3% in August, reversing a gain in July and returning to the downward trajectory it had been on.

Because permit issuance is an indicator of future building activity, the decline suggests that commercial construction spending is set to falter in the coming months, according to Zentner.

From the note (emphasis hers):

“The latest data from the Census Bureau showed nonresidential construction spending at $405.21 billion annualized in June — our Non-Resi Permits Index suggests private nonresidential construction spending is on track to peak around $415 billion in 3Q; however, the recent weakness in the non-resi permits index raises downside risks for the trajectory of construction spending into year-end.

Zentner also noted minutes of the Federal Reserve’s July meeting, which showed that there was discussion about “potential overvaluation” in the market for commercial real estate.

Morgan Stanley’s call echoes recent warnings on the commercial real estate market from Deutsche Bank, Pimco, and others. It comes at a time when weak business spending is weighing on overall economic growth, even as consumer spending remains robust.

Like Deutsche Bank, Zentner wrote that a forthcoming slump in spending has been indicated by tightening lending standards for commercial real-estate loans.

The most recent Senior Loan Officer Opinion Survey report showed that businesses continued to face tighter standards for getting commercial and industrial (C&I) loans. That’s because banks are facing increased competition, and economic conditions are improving, as Business Insider’s Bob Bryan noted.

In the third quarter, a net 8.5% of loan officers reported tighter standards for lending to medium- and large-size firms, up from -7% a year ago.

During the last six months, however, non-residential construction spending has declined only in some sectors including health care, transportation and manufacturing.

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