Small businesses defaulting on rent are canaries in the coal mine for North America’s economy

On the surface, it seems like an insignificant statistic in a sea of major economic news: There was a big jump in the number of small businesses in the U.S. and Canada that couldn’t pay their rent in full and on time in October.

But of all the canaries in all the coal mines, this seemingly minor development – and the trends it will spawn – is among the most critical to watch, as the North American economy lurches toward recession while carrying the heaviest inflationary weight in four decades.

Since small businesses account for two-thirds of new jobs created, the knock-on effect of this shortfall and the reasons behind it are harbingers of hard times ahead. And in the U.S., such prospects are a major influence on voters heading into the coming midterm elections on Tuesday – with many pollsters predicting a sharp shift right to a more business-friendly Republican-controlled Congress.

According to a survey of more than 4,700 small businesses released this week by the Alignable Research Center in Boston, 37 per cent of U.S. small businesses came up short last month, up seven percentage points from September, when delinquencies were at a six-month low. Small businesses in Massachusetts, New Jersey, New York and California – all states with Democrat leadership – saw the worst of it.

The situation was more acute in Canada, where 42 per cent of small businesses couldn’t make the October rent, up slightly from the previous month, according to the study. Hardest hit were small businesses in British Columbia, Ontario and Alberta.

While the numbers between the two countries may be slightly different, the causes are very much the same: “The cumulative negative impact of more than a year of high inflation, which has absorbed most sales gains,” said researchers for Alignment, a network of more than seven million small business members in communities across North America.

The specifics are well-documented: rents have risen for more than half of small businesses, gas prices are higher, supply chain costs are up, labour costs are soaring and there are widespread shortages of workers, and consumer spending is slowing – and all this against a backdrop of growing fears of recession.

Consumer spending was a particularly strong factor in the shortfalls. Almost 60 per cent of business owners surveyed noted a marked drop from the prior month.

In many U.S. sectors, the delinquency rates were much higher that the 37-per-cent average. Educators, car dealers, restaurants and retailers all had rates well over 40 per cent. The automotive sectors and restaurants were particularly hard hit, recording their highest delinquency rates for 2022, at 49 per cent.

Car dealers were hurt by sharply rising interest rates, since big-ticket items are often bought on credit. In the U.S., rate hikes by the Federal Reserve have driven up new-car financing rates to 5.7 per cent in the third quarter, up from 4.3 per cent a year ago and the highest level in three years, according to Edmunds analysts. In Canada, the average car loan rate is 6.6 per cent, according to WOWA.ca.

Nearly half of all restaurants surveyed – 49 per cent – could not pay their rent in October, up 13 percentage points. Some 43 per cent of retailers defaulted, up 12 percentage points.

Real estate and housing construction companies also took a hit, as mortgage rates in the U.S. nudged 7 percentage points, cooling off a red hot real-estate market and driving down building activity.

With the holiday season coming, there is some optimism that spending will rebound, at least momentarily. And many U.S. voters, including staunch Democrats, have told pollsters they rank inflation and economic concerns so high that they will break with their party loyalty and vote Republican in hopes that a red wave will make things better.

Red wave or not, with costs and interest rates rising, the job market shrinking, and consumers dipping into their savings more than ever just to make ends meet, the prospects of saving the small-business canary are slim. At best, it will remain on life support for the foreseeable future.