New Geography

Author: Elliott Pollack

  • Beyond The Bailout: What’s Next in the Housing Market?

    The Emergency Economic Stabilization Act of 2008 (we’ll call it the “Bail Out”) was signed into law on October 3rd. This, combined with the new reality in capital markets and current economic conditions, will result in some major shifts in the outlook for housing over the next few years. It is always possible that the federal government will try to do even more to fix what will be an agonizing housing problem over the next few years, but seems unlikely even Bernake, Paulson or their appointed successors will be able to change the basic story line.

    The Credit Market
    Let’s set up the dynamics. The era of easy credit, especially in terms of mortgages and home equity lines, is over. The 2002 through early 2006 period will turn out to be an aberration in history. During that period, about all a person needed to do to qualify for a mortgage was to be healthy. For the foreseeable future, we will see the return of such requirements as a down payment and the ability to repay your loan based on income, along with a good credit history, that will allow a person to qualify. The tighter credit and the slow down of the economy already is making it difficult for all but the best borrowers to get mortgage loans. Thus, the housing market will remain under significant pressure and the excess supply will be absorbed only slowly.

    The Consumer
    Consumers have accumulated far too much debt; they don’t have much in the way of traditional savings; are faced with job declines and declines in hours worked and are also facing a reverse wealth affect (i.e. people tend to spend more when they feel richer and less when they feel poorer). In the 1990s, consumers felt wealthier because the stock market did very well. Studies of the wealth effect indicate that people spend about five cents out of every dollar of increased net worth from stock and housing price appreciation over about a three to five year period of time. In the early part of this decade, not only were housing prices rising rapidly, but, almost unbelievably (in retrospect), easy credit allowed people to use their house as a credit card. The result was a boom in retail spending and home buying. In fact, the rate of homeownership in the U.S. went from a long term average of about 65% in 2002, to a high of nearly 69% in 2006. The percentage of people who bought homes, as a percent of total households, reached a record level.

    Supply and Demand
    Today, there are roughly two million more homes for sale in the nation than normal (4.3 million new and resale listings versus the long-term average of 2.3 million homes for sale). In addition, foreclosures are skyrocketing and are likely to stay high for quite some time. Many recent buyers simply were not financially ready for home ownership’s financial realities. Basic demand has diminished significantly as the number of prospects who can qualify has declined. Put all of these things together and you will have a period where not only will there be fewer homes purchased, but there will be high levels of foreclosures, a decline back to the normalized level of homeownership. There will be fewer people moving (i.e. if you can’t sell your house in California, Michigan or Pennsylvania, you are not moving to Arizona). What this implies is that the demographic demand for housing will be lower than normal over the next few years until the excess supply is absorbed.

    How long will this take? Analysis suggests that it is two to four years away nationally and longer in the bubble states: Arizona, California, Florida and Nevada. All this suggests that as the homeownership rate comes down, more people will be moving to apartments, people will “double up” or move back home. As a result much of the housing demand will be absorbed by foreclosures and the excess existing housing inventory, mitigating the need for significant new housing in the near term.

    If you add this all up, this also means slower growth in what were normally rapid growing areas (like Phoenix) where a full recovery could take four to five years for housing. As the home-ownership – including condos – rate moves back to its long term trends there will be a shift back to apartments.

    Overall, there will be fewer single family homes demanded, more apartments demanded, and the homes that are demanded will be more affordable. The most affordable areas will continue to be at the edge of town. In addition, given how difficult it has been to get the entitlements necessary for new apartment construction in areas like Phoenix over the past several years along with the number of condos that are being converted back to multi-family rentals, rents are likely to increase past 2009 or 2010 as the excess supply of rental single family homes, condos and apartments are absorbed.

    Overall homeownership will still be the American dream, but that dream will not again be something people think about until housing prices stop declining and start recovering. It’s going to be a tough ride, particularly in Sunbelt ‘boomtowns’ like Phoenix.

    Elliott D. Pollack is Chief Executive Officer of Elliott D. Pollack and Company in Scottsdale, Arizona, an economic and real estate consulting firm established in 1987, which provides a broad range of services, specializing in Arizona economics and real estate.

  • Phoenix: “Not Dead Yet!”

    To paraphrase Mark Twain, “The report of Phoenix’s death has been greatly exaggerated.” To be sure, the Phoenix metropolitan area, for the first time in years, is suffering through a period of economic distress both in absolute and relative terms. However, the distress is purely transitory, caused primarily by the ripple effects of a 75 percent decline in building permits over the last three years combined with the national slowdown in economic activity. The underlying fundamentals remain strong as does the long-term outlook.

    Builders in greater Phoenix, like in many communities, overbuilt during the boom. This creates an oversupply that has been made worse by poor conditions for home sales in places like California, or Michigan, primary places from which people come to Phoenix.

    Yet it’s critical not to confuse today’s short-term setback, as many in the national media do, with setting the table for long-term stagnation. This pattern has been seen during previous recessions, notably between 1988 through 1992. After that, greater Phoenix came back with job growth during the expansion that started in November 2001 at three and a half times the national average.

    The fundamentals that drove that recovery have not changed. These include factors such as climate; lifestyle; geographic location; pro-growth attitude; competitive tax structure; focused incentives; and relatively low cost of living. The long-term dynamics remain in place.

    Why do we Grow?
    Let’s consider why some places within the United States grow and others do not. The first test is simple. Do the people want to live in that area?

    The quality of life factor, of course, lies in the eye of the beholder. Fortunately, there is an objective measure: people vote with their feet. People simply want to be there. This explains why areas of the country that supposedly have great business climates, South Dakota, with some exceptions, do not enjoy rapid population growth.

    A second factor lies with the business climate relative to the area’s competitors. Are there specific local policies that result in constraints on work practices and the application of better production methods? Can firms operate profitably relative to alternative locations? Does the area embrace business expansion and competition?

    Greater Phoenix wins here too. Boiled down it’s a matter of whether the government is getting in the way? Specific local policies can result in constraints in work practices and the ability of individual firms to earn a reasonable profit. For the most part, Phoenix remains a good place to grow a business.

    All Jobs are Not the Same
    These factors are critical in the formation of “export jobs” as opposed to domestic sector jobs. Export sector jobs are generally higher paying jobs. They are created because a company’s product is sold primarily outside of the local area. On the other hand, domestic sector companies serve local markets so they have to locate locally. A domestic sector company; a retailer, insurance agency, title company, lawyer, or barber; are chasing local income. It’s the export jobs that matter most. Think of the ghost towns of the old west. They blew away because their reason for existence — a mine, a rail crossing, or farming — lost their relevance.

    Greater Phoenix thrives because it generates many “export” jobs in manufacturing, tourism and export service base Why these base industry companies locate in Greater Phoenix as opposed to another city stems from actors described in the book “Barriers to Riches.” The region provides a competitive advantage in their ability to implement the latest technologies and make a reasonable profit — without a great deal of costly government interference. Yes, there are other relevant factors such as proximity to markets but the key lies in our ability to attract sufficiently skilled labor that can be applied and earn reasonable profits.

    The Real Estate Outlook
    Phoenix appears to be taking a beating in terms of relative growth this year. A correction is in order. But over the next two years or so the excesses of the sub-prime mortgage crises will have worn off and Phoenix’s intrinsic strengths will assert themselves again.

    This recovery will include many of the newer areas. The press is asserting that areas at the edge of the metro area will no longer grow due to gasoline prices. This is a vast overstatement. These communities will change, and so will the habits of the people who live in them. They will replace their pick-up trucks and SUVs for Priuses and their hybrid competitors. Some will work full or part-time at home. Companies may move more of their operations closer to the outer suburbs, if that’s where the majority of their workforce lives.

    Critically, keep in mind that jobs opportunities tend to follow people. Unlike many cities, greater Phoenix does not have one job core, it has several. And, jobs tend to migrate out to where the labor shed is. That will continue to be the case. Many of the areas that are the outlying today will be the job centers of tomorrow.

    On the other hand, the market for dense development — the favorite of planners and pundits — may be limited. Even during the strongest period of housing starts on record, high-rise condos only accounted for 2.2 percent of all the housing construction in greater Phoenix. But that market has fizzled. Many high-rise projects throughout the area have been put on hold or have been cancelled due to market conditions. Some will never be built. Others (in Tempe and Downtown Phoenix) may be turned into student housing. Indeed, since 2001, 7,400 units have been added to the high-rise condo inventory. Only 3,700 of those are sold or have a hard contract and 3,700 remain unsold or unreleased. That compares to total single-family housing starts during that period of 330,000 units.

    High-rise condos will continue to be a niche market, accounting for a relatively small percentage of total housing. The predominant housing style in greater Phoenix will remain a single-family home on a 45 to 75 foot lot on the periphery of town where land is plentiful. Phoenix will remain a place where people can have their piece of the American dream — and with the end of the bubble it will become affordable once again.

    Greater Phoenix Outlook
    A combination of events — the national recession, the local housing bubble, and the rapid rise in food and oil prices — have all worked against greater Phoenix in the short term. But, the national economy will recover as it always does. Housing supply and demand will get back into balance. If oil prices remain high, people will substitute vehicles that get better mileage. But although greater Phoenix is going through a difficult period at present, do not bet against it in the long run.

    Elliott D. Pollack is Chief Executive Officer of Elliott D. Pollack and Company in Scottsdale, Arizona, an economic and real estate consulting firm established in 1987, which provides a broad range of services, specializing in Arizona economics and real estate.