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Recovery is here for real estate
Dec. 24, 2006 12:00 AM

Economists don't usually top the list of most desirable holiday party guests, but this year has been different. My popularity has ratcheted upward because the No. 1 topic among Arizona homeowners (as well as lenders, builders and real estate agents) seems to be: "How long before real estate markets recover?"My answer, that real estate markets have recovered, usually sends them to the punch bowl. The frenzy-driven appreciation increases are over. The slowdown in new-home building accompanied by stable home prices show that the market is getting out of bubble mode. In my view, we have recovered now that the pace of sales of both new and used homes is back onto a sustainable steady growth path. As an analogy, consider a patient with a raging fever, rushed into the emergency room. After successful treatment, we want the fever to be gone and the temperature normal. Of course, we don't want a stone-cold corpse. Like that patient, the Arizona housing market has recovered to a more normal temperature, with a good prognosis.

Far from stone coldAnd the market is far from stone cold. As of now, it looks like resales of single-family homes in the Greater Phoenix area will approach 70,000 for 2006. Although resales will be down by a third from the 110,000 record set in 2005, this year still will be the fourth-strongest ever for resales. Assuming Arizona job growth and population flows remain strong, 2007 shouldn't be much different.Single-family permits for new homes also are down by about a third for 2006, as builders have pulled back. But new-home buyers are still active, inventory is being worked off, and actual sales will be down at most 15 percent from the torrid pace of 2005. Homeowners bemoan the sudden stagnation in appreciation. But the reality is that a conflux of unusually strong demand and easy mortgage money triggered price rises that could not be expected to continue.In the 12 months from midyear 2004 to summer of 2005, prices were up 30 percent on single-family resales, according to the Arizona index of housing prices from the Office of Federal Housing Enterprise Oversight in Washington, D.C. Appreciation like that won't be repeated anytime soon, perhaps for many years.Consider that 12-month jump of 30 percent in the context of the past two decades. If a family bought a new home in Phoenix in 1985, that property increased in value at the glacial rate of about 2 percent per year for the following 10 years. The gain in value was 26 percent for the whole decade of 1985-95. From 1995 to 2000, the typical Arizona home appreciated again by almost the same amount, 27 percent. Then, it took half the time, five years, as markets were bolstered by the economy of the roaring '90s.Fast-forward from 2000 to now: Home values have doubled. Prices increased more in the past five years than in the previous 15 years combined.Although most analysts expect that reported sales prices averaged over the whole Phoenix market may temporarily dip somewhat (5 to 10 percent) over the next year, these meager declines are coming off inflated values of magnitudes unseen in the previous two decades. New-home buyers in Arizona shouldn't worry that price declines will wipe out value. In our growing economy, prices will continue to rise, albeit along a more stable growth path in the future. But don't expect a 30 percent gain in any future 12-month period. Another concern is whether the residential slowdown will lead the economy into recession, as we saw in 1991 and 2001. There are some differences now. Compared with those previous slowdowns, Arizona population growth is stronger. The annual increase today is about 3 percent, which translates to about 180,000 new residents per year and creates a base demand for housing. In 1991, population growth fell to 1.7 percent and weakened real estate demand.
Economic strengthAnother difference is strength of the overall economy. Job creation came to a halt in Arizona in the recessions of 1991 and 2001. According to the most recent figures, Arizona leads the nation in job growth, although the pace has moderated as 2006 comes to a close. But as of now, construction employment is at an all time high (253,100 workers) and is still the fastest growing sector of the Arizona economy. During the second half of the 1980s and through 1992, construction lost jobs for five consecutive years. Through the first nine months of 2006, construction employment was up by more than 10 percent over last year. Construction jobs are growing because, although new-home building is slowing down, other building categories are expanding. In the '80s, 1991 and 2001, the residential downturn was accompanied by absolute drops in commercial and industrial building. But those two components, along with infrastructure (light rail, schools), are robust today.The Blue Chip forecast for Phoenix from Arizona State University's W.P. Carey School of Business projects that over 3 million square feet of office space will be added in 2007, along with 6 million square feet of retail space. These are increases over 2006 building.
Residential marketWhat pain there is in the local real estate sector is felt most in the residential market. Those suffering are home builders with too much inventory, who will cut back on new starts next year. Suppliers for home builders will be caught in the undertow. And those residents who bought homes in the past couple of years and now want to sell may take a loss, either in real terms or relative to what they thought they would get. Other effects of the deflating bubble are yet to play out. Adjustable-rate mortgages that reset may put a squeeze on some households. And home equity withdrawals to support consumer expenditures are dwindling. As 2007 unfolds, the volume of home sales and prices in the residential market will gradually move back onto a steady, sustainable trend line. Annual price appreciation will be in the 4 to 5 percent range recorded from 1985 to 2000, rather than 30 percent per year. Compared with the go-go markets of the past couple of years, indicators will all be dialed back. In my opinion, that signals the market is getting back to normal, and I call that a recovery.Lee McPheters is director of the JP Morgan Chase Economic Outlook Center at the W.P. Carey School of Business, Arizona State University.