Real Estate Capital & Investments

by Drew de la Houssaye

Median home prices in Los Angeles reached a peak in August 2007. By February 2008, prices had dropped 16.5%. Homeowners, investors, realtors, homebuyers, builders, mortgage companies, banks and everyone working in any industry dependent upon home sales and construction want the answer to the same question…”Where is the bottom?”

Word on the Street

There is a lot of noise about the housing market. TV commentators, newspapers and water cooler chatter…everyone has an opinion about when we hit bottom. Some of the predictions seem to be predicated upon hard data. See the nice chart below that clearly shows that 2008 will bring an end of the huge wave of subprime loan adjustments causing all of these foreclosures.

Note: this chart was from June 2007. So we are “not here” but two-thirds of the way through the bulk of the ARM adjustments depicted in the chart.

Based upon this information, one could argue that home prices might bottom in 2009. That was the interpretation of Lawrence Kudlow on his CNBC politics and economics show, Kudlow & Company, on April 16, 2008.

As the Federal Reserve steps in to cut interest rates and bail-out financial institutions crippled by the credit crunch, the stock market rallies, and commentators pronounce that the market is a lead indicator that the home price bottom is only 6 months away.

Even on the front line, I see anecdotal evidence that the bottom is near. More and more investors are applying for financing to pick-up bargains, and investors are forming numerous private money funds to get them the money they need. I hear talk everyday about the bargains to be had in bank-owned properties, foreclosures, short-sales and rehab flips. Surely, investors are on the sidelines just waiting to jump in at the bottom. Meanwhile, home sellers are stubbornly resisting lowering their asking prices because the bottom must be right around the corner. Moreover, Fannie Mae and Freddie Mac can now offer jumbo loans. “We are saved!”

Everybody is wrong.

The Facts

All of the empirical economic data predict that home prices will continue to drop for at least another 4 years. And, that is the optimistic forecast. Realistically, home prices will continue to decline for a total of 8 to 10 years. During this decline, home prices in Los Angeles will drop nearly 50% from their highs of August 2007. Robert Campbell, a leading California real estate economist, predicts that this will be the largest decline in home prices since we began keeping records in 1890.

Recent History

In order to fully explain why the home price downturn will be protracted, I must first give you a quick recap of how we got into this situation in the first place.

In 1988 US home price began to drop after a run-up fueled by Wall Street’s takeover of mortgage lending from sleepy old savings & loans. This drop continued for 9 years, until 1997 when median US home prices finally began to rise again.

In 2000, the Federal Reserve was concerned that the Y2K bug would seize the country’s computers, and the banking system would fail. As a safety measure, they flooded the economy with currency, and lowered interest rates. This had the unintended result of homeowners who were previously upside-down in their mortgages, flooding mortgage companies with applications to refinance into a better rate.

Three months later, the dot-com bubble burst, and the Federal Reserve, again concerned about the economy becoming disrupted, lowered interest rates again. This cheap money caused home prices to continue rising and caused even more refinancings.

A third crisis hit in 2003. 9/11. In the aftermath, the American consumer was paralyzed. GM couldn’t give cars away, and the Federal Reserve stimulated the economy with even more interest rate cuts. It worked. The economy didn’t stall.

However, home prices were now on an upward spiral fuelled by the perception that home prices always go up. They were also help by the availability of cheap money the Fed was pumping into the economy and easy credit terms. Everyone knew someone who was becoming rich just from owning a house. This caused a huge demand for new housing. As home prices continued to spiral upwards, people began to refinance just to take cash out of their homes to finance consumer spending. “Who cares? The house is just going to keep going up in value.” Homes had become personal ATMs.

The demand for home loans was so great that the mortgage industry and Wall Street had to hire a huge number of people to handle all of the processing. These were mostly twentysomethings with virtually no experience in mortgage lending, underwriting, securitization or risk analysis. They were told, “Let’s close these deals as fast as possible, and you’ll make a lot of money. Just copy what the guy next you is doing.”

Sure some well intentioned, smart people knew that home prices were unrealistically high, but they couldn’t do anything about it. If they refused to do the loans, their competitors would take the business instead. If a loan officer wouldn’t lend to a consumer, a different loan officer would. If a mortgage company would buy a portfolio of questionable loans, and different mortgage company would. If a ratings agency wouldn’t give an investment bank’s mortgage bonds a AAA rating, another one would. If a hedge fund manager didn’t give his investors the profits promised by these bonds, they would find another fund manager.

Why didn’t the regulators put the lid on things? In my opinion, the regulators were deliberately looking the other way. Everyone wanted this to happen: consumers, lenders and investors. There was no constituency asking for this to stop. Everyone was making money. Who is the injured party? In my experience, regulators who call for preemptive measures are usually shouted down, and ridiculed for predicting that the “sky is falling.” There is seldom political will to fix a problem until events actually achieve crisis levels.

The housing and mortgage markets were completely out of control.

By 2006, the mortgage industry had lent money to virtually every qualified borrower, but no one wanted the party to stop. In order to keep things going, lenders began to put the least qualified borrowers into the most risky loans, and they did this at a time when homes were at their absolute top value.

Wall Street simply stopped buying these bad loans, and more than 100 mortgage companies failed in the first three months of 2007.

It is these risky loans made during 2006 and 2007 that were the first to fail. These failures eroded the values of their neighbors’ homes and caused a domino effect of foreclosures. Moreover, these failures exposed that fact that ratings agencies were not properly evaluating the riskiness of these mortgage bonds, and called into question all bond ratings. All types of credit to froze up. It was August 2007, and the credit crisis had begun. Jumbo loans nearly vanished, and home values in Los Angeles (largely dependent upon jumbo home loans) began to tumble.

That brings us to today.

5 Reasons for Declining Home Prices

Here are 5 empirical reasons why home prices in Los Angeles will drop nearly 50% over the next 8 to 10 years:

1) The Easy Credit is Gone
2) The Recession
3) Housing Affordability Ratios
4) The A-Paper Loan Crisis (hasn’t happened, yet), and
5) Housing Bubble Symmetry

Much of the boom in housing prices was a result of easy lending terms offered by the mortgage industry. The biggest culprit was the stated income 100% financing loan. Virtually, anyone with a pulse could get into a home, without having to prove their financial responsibility or having to invest their own money into the home. Many borrowers deliberately misled lenders, by buying numerous homes under these terms claiming that each was a primary residence, when in fact they were purchased for speculation.

Over 100 mortgage companies have failed, and both Fannie Mae and Freddie Mac are technically insolvent.

The credit crisis has also caused a shortage of funds for jumbo mortgages, which comprise a major share of financings in the Los Angeles area.

Now that this easy money is gone, jumbo loans are scarce and people have to actually invest their own money and/or prove their financial qualifications, demand for homes has shrunken and home prices will continue to decline.

The housing boom financed the majority of growth in our nation’s Gross Domestic Product. Mortgage equity withdrawals (MEWs) measure the amount of money people took out of their homes to pay for consumption. During the previous housing cycles, MEWs financed only 12%-17% of the growth in GDP. During this housing cycle, 66%-100% of the growth in GDP was funded by people spending the equity in their homes. In other words, if people hadn’t borrowed against their homes to buy stuff, real growth in GDP would have barely achieved a 1% growth rate.

Homeowners have depleted much of their equity either because of MEWs or because of falling home values. So, they can no longer borrow against that equity to make new purchases.

The housing downturn means a loss in jobs in construction, real estate, related retailers, and service companies. With this loss of employment, and the loss of economic stimulation in other sectors financed by mortgage equity withdrawals, a recession is inevitable.

Unemployed people don’t buy new homes. Neither do people who can’t sell their homes because they are owe more than the house is worth. This contraction in demand will put further downward pressure on home prices.

Since World War II, median home prices in Los Angeles have averaged 4 times median income. This is what is normal for the area. The city has been running a housing price fever, though. At its peak, August 2007, median home prices was 10.5 times median income. To return to normal home prices must drop back to the normal 4 times median income.

The combination of low interest rates and easy credit caused an a-typical disconnect between income and home prices. Now that the conditions that caused this disconnect are gone, median home prices will inevitably return to their historic mean of 4 times median income. This implies up to a 57% drop in prices from the August 2007 high, with a small portion of this correction coming from a rise in income.

Los Angeles housing prices have reverted to this mean ratio of 4 times income after each of the last two housing bubbles: in the 70’s and the 80’s.

A lot of people are calling a bottom to housing prices in 2009. They are, like Lawrence Kudlow, looking at charts depicting the re-setting of sub-prime ARMs, and based upon the fact that the bulk of these resets will be over in 2008, predicting that the worst of the housing crisis will soon be over.

They are looking at the wrong chart.

There will be another wave of foreclosures caused by the re-setting of the Option-ARM products sold in 2006 and 2007. In a rising interest rate environment, it was one of the few ways to actually lower a borrower’s monthly payments. The resets on these loans will occur in 2010 and 2011, and they will set off a 2nd wave of foreclosures. This time, they will be A-paper foreclosures, and we will see significant foreclosures for the first time in affluent communities like Brentwood, Beverly Hills, Pacific Palisades, Encino, Calabasas, Bel Air and Malibu.

Communities already hit with the sub-prime foreclosures, like Sacramento, the Central Valley, Inland Empire, Palmdale, Lancaster and San Diego will have another round of foreclosures. This time it will directly affect A-paper borrowers who can’t refinance their Option-ARMS because falling home prices have left them with no value in their homes.

These 2010 and 2011 A-paper and Alt-A foreclosures will approach the same level of the sub-prime implosions that we are currently experiencing. For this fact alone, it is highly unlikely, that we will see a turn-around in home prices, before 2012, and as I’ll demonstrate next, there is a good reason to expect the decline to continue another 3 – 5 years beyond that.

Look again at a historical chart of US median home prices. You will notice that the housing price bubbles in the 1970s and 1980s were both symmetrical. That is to say that home prices decline over about the same number of years that it took for them to rise. In the 70s, the price pattern made a symmetrical chart pyramid, and in the 80s, it formed a nicely rounded mound. This isn’t good news, because this phenomenon predicts that the current downward slide in home prices will continue about as long as the price climb took. That price climb took 10 years. Since the peak in Los Angeles housing prices was in 2007, prices could decline until 2017.

Human nature being what it is, a lot of people reading this will say that this is a wild “end-of-the world” scenario, but let me remind you that the last decline in home prices lasted almost as long, for 9 years, 1988 to 1997.

There is also another precedent for this long symmetrical decline. After a 14 year price decline in Japan, their housing market finally began to rebound in 2005

Housing price data since 1890 have been graphically incorporated into a clever roller coaster video. Watch the video below. It will give you a visceral sense the number of ups and downs of US home prices over the last 120 years, and of the current price decline. Pay special attention to the last part of the ride; it represents our current situation. If you still have any doubts about the direction the housing market is headed, it will make you into a believer.

Click here to open video window

Still in Denial?

The evidence is overwhelming, but human nature is what it is. Most people reading this will tell themselves that the market in general may act like this, but that their own circumstances are different. Unfortunately, there isn’t a strata of the housing market that is immune to these price pressures.

Demand for homes at all levels is interconnected. It’s a kind of food chain. In order for demand to be fueled at the top, there must be demand at the bottom, pushing everyone upwards. First-time home buyers must be able to afford and qualify for financing to purchase entry-level homes. This allows the sellers of these homes to use their equity to move up into a nicer neighborhood and a bigger home. That purchase, in turn, allows people in the middle of the market to climb their way into the best homes in the best neighborhoods.

Unfortunately, there are dislocations at all levels of the housing market. The 100% financing option was originally intended to help facilitate first-time home buyers gain access into the housing market has been greatly reduced. They are harder to obtain and offered by fewer lenders. The middle of the market has glut of inventory, from homeowners attempting to escape unmanageable payments and with banks trying to dump repossessed properties. Moreover, many of the loan products which allowed these consumers to purchase a home, no longer exist. It will take years of demand to absorb all of this excess inventory. Consequently, with no upward pressure on home price in the middle, demand from middle market homeowners trading up into premium neighborhoods will also subside. The top of the market isn’t already without its own problems. There is already a shortage of jumbo loan financing, and many middle-class people used the aggressive Option-ARM loan products to move into the best neighborhoods. When the maximum payments on these loans re-set in 2010 and 2011, there will be a rash of foreclosures collapsing prices in the best neighborhoods, as these overreaching, middle-class homeowners get a dose of financial reality, and their mortgages implode on them.

If this forecast were true, wouldn’t it be reported in the news media? Well, not necessarily. The first reason is that news organizations report events which have already occurred. They are not in the business of making predictions. The second reason you won’t see this forecast in the news is that the media gets its housing data from organizations that have an interest encouraging people to buy more houses: institutions like the National Association of Home Builders, the National Association of Realtors and big banks like Wells Fargo. Otherwise detailed economic reports from these institutions either avoid the topic completely or equivocate about the expected depth and duration of the housing downturn. The CEO of Wells Fargo was on TV yesterday. When the housing downturn was brought up, he began his reply by saying something like, “At some point, we will reach a bottom and housing prices will stabilize.” That’s a pretty vague response from someone collecting a huge paycheck from his shareholders to know the exact answer to that question. He was vague by design. If he went on national television and predicted the bottom was 10 years away, loan applications for new home purchases would immediately fall-off.

Stay Smart

To track how far home prices have to fall in a particular city, you can find price-to-income charts at Housingtracker.net and additional charts at MacroMarkets.com. Look for the 1997 price-to-income ratio, and compare that to the current ratio, and you will have a good estimation of how far home prices in that city have to fall. These charts can also tell you when home prices have reversed and started to rebound.

By Drew de la Houssaye 

The MTA is planning on building a train route, this year, to run along the long abandoned rail line on Exposition Boulevard from Downtown to Santa Monica.  Rather than build the train below grade (such as in a trench), they are building it at grade (at the same level as pedestrians and motorists).  This is the same way they built the Blue line which has already earned the title, “the deadiest train in America.”  

This proposed Expo line will send a train every 2.5 minutes though USC Homecoming Day pedestrians, through Coliseum event traffic gridlock, and within 50 feet schools with children crossing (at Dorsey)s at a rate of 105 students per minute. 

Gloria Jeff submitted a memo on behalf of the City of Los Angeles Department of Transportation protesting that the MTA’s safety estimates for crossings at Exposition Park ignored the massive increases in pedestrian and automobile traffic during Coliseum events.  She was fired the next day. 

The MTA’s solution for handing the 3:00 pm rush of student crossings is to create a “holding pen” for our children, until the train passes.  Several concerned citizens, myself included, immediately observed that if a collision where to occur, everyone standing in one of these “pens” would be directly in the path of a derailed train.

The Expo line will kill people, and unlike the Blue line (”the deadliest train in America”), it will kill en mass. 

A train at grade must sound it’s horn 100 yards before it enters every intersection.  That is 240 horn blasts per day.  Travel along the existing Blue line, and you will see “for rent” and “for sale” signs on homes all along its route.

This train will undoubtedly relieve east-west traffic on the 10 freeway.  However, as proposed, it will simultaneously exacerbate commuter gridlock on all north-south streets between Downtown and Santa Monica.

A train running below grade (in a trench), requires no horn blasts, no “holding pens,” no need for sound walls (graffitti magnets), no crossing gates and no need to slow the train down for intersections.  In fact, a below grade train would operate so efficiently, that its total cost to build and operate would be less than the current “at grade” plan.  

Now, here is the really annoying news.  The MTA had originally intended to build the Expo route below grade, and they would have qualified for massive federal subsidies, but they changed the plan.  When asked why they would do this, a Federal Transit Administration official called the MTA, “Unsophisticated.” Even though a below grade project would have a lower total cost (construction plus operating costs), the “at grade” plan was cheaper and easier to build (which ignores its higher cost to operate).  There is no free lunch.  Someone always pays, and entire communities will pay for it with reduced home values, increased noise pollution, snarled traffic and avodable deaths.

USC doesn’t want this train at grade level.  The LA Unified School District doesn’t what this train at grade level.  Culver City doesn’t want this train at grade level. Homeowners don’t want this train at grade level.  Parents don’t want this train at grade level.  And, when they announce the plan for Santa Monica, I’m sure they won’t want it at grade level, either.   Yet, the MTA board is continuing with this deadly plan. 

Please help us convince them to pursue a safer and more economical solution. Please take a minute to visit http://www.fixexpo.org/ and to sign the petition at http://www.PetitionOnline.com/EXPO/petition.html .

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Drew de la Houssaye is the Managing Director, Real Estate Capital & Investments at Source 1 Financing. He has over 20 years of experience in financing, investing and managing both residential and commercial real estate. Need more information? Please, contact us.

By Drew de la Houssaye

The recent headline news regarding the mortgage industry will have a widespread effect on home values and the availability of credit. 

Home foreclosures are projected to exceed $100 billion over the next six years (MSN March), and during the first ninety days of 2007, suddenly and unexpectedly thirty-six of the largest mortgage companies in the country have gone out of business.     

The foreclosure rate in California is already 200% higher than last year and projected to continue increasing though 2008.  Each foreclosure will have a negative impact on the value of surrounding homes.  Moreover, Congress and Wall Street are pushing us to tighten loan approval guidelines.   The combination of tighter loan guidelines and falling home values will make it harder to refinance properties in the next few months, creating what economists are calling a “liquidity crisis.”   Many homeowners who are qualified today, will not be eligible for a loan a few months from now.

Unqualified for a new loan and faced with higher adjustable payments, many more homeowners will decide to place their homes on the market, further weakening already falling home prices.  

Consequently, if you have family or friends who are facing higher adjustable mortgage payments over the next year, you should advise them to obain a stable and secure loan ahead of the market downturn.

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Drew de la Houssaye is the Managing Director, Real Estate Capital & Investments at Source 1 Financing. He has over 20 years of experience in financing, investing and managing both residential and commercial real estate. Need more information? Please, contact us.

What started out as a pause in rate increases last month began to look more like a full halt yesterday.

The Federal Reserve left its short-term interest rate target at 5.25% for a second consecutive meeting. It also warned that it remains concerned about inflation, and thus if it changes rates soon, it is more likely to raise them than lower them.

The statement accompanying yesterday’s decision suggested that, since pausing in its two-year string of rate increases last month, the Fed has become more confident that standing pat is justified. In explaining yesterday’s decision, it cited the quickening decline in housing activity and easing inflation pressure from energy.

Investors, however, increasingly expect the Fed not just to remain on hold, but to cut rates at least once by next June and again by December 2007. Ten-year Treasury bond yields have fallen, ending yesterday at 4.73%, down from 5.25% in late June. Those expectations may not match the Fed’s, at least for now. Indeed, its statement did little to hint a rate cut would be on the table in the near term and financial markets pulled back slightly in their anticipation of one.

Stocks, meanwhile, which have been rallying because of falling oil prices and on hopes the Fed is finished raising rates and the economy escapes recession, extended their winning streak. The Dow Jones Industrial Average rose 72.28 points yesterday to 11613.19, just 110 points short of its January 2000 record.

In its statement, the Fed said growth is moderating, “partly reflecting a cooling of the housing market.” By discarding last month’s characterization of housing as “gradually cooling,” the Fed acknowledged the slide in home construction, sales and, in some regions, prices has picked up speed.

It said that while the “core” measure of inflation, which excludes food and energy, remains “elevated,” it was likely to moderate in part because of “reduced impetus from energy prices.”

Oil and gasoline prices have fallen sharply in recent months. Oil futures on the New York Mercantile Exchange fell $1.20 yesterday, or nearly 2%, to settle at $60.46 a barrel — their lowest level in six months and down 22% from the nominal high reached July 14. In theory, such a decline has mixed implications for the Fed. Lower energy prices reduce inflationary pressure, which would call for the Fed to lower rates. They also boost consumer purchasing power, which can improve growth prospects and would call for an increase in rates. The Fed statement suggests it considers the former effect as more important.

While economists differed on what the Fed’s next action is likely to be, they agreed that the small changes in its statement signaled greater comfort with leaving rates where they are, despite its stated bias toward raising rates.

“We see these wording changes (and absence of other potential changes) as a step in the direction of a neutral balance of risks,” Peter Hooper, chief economist at Deutsche Bank Securities, wrote in a note to clients. He predicted the Fed would drop its bias to higher rates either at its next meeting, on Oct. 24-25, or in December, and would cut rates by March.

The Fed’s statement conveys “more of a sense of comfort of being on hold,” agreed Bruce Kasman, head of economic research at J.P. Morgan Chase. He noted that inflation remains the Fed’s paramount concern. He also expects another rate increase by March.

Ten of the 11 voting members of the Federal Open Market Committee agreed to yesterday’s decision not the change the federal-funds rate, which is charged on overnight loans between banks. The Fed had increased that rate at 17 consecutive meetings before pausing last month. As in August, Federal Reserve Bank of Richmond President Jeffrey Lacker dissented, preferring a quarter-point increase. It was the first time in eight years an FOMC member dissented at two consecutive meetings in favor of higher rates, said David Resler of Nomura Securities. The last time, he said, the Fed’s next move was to lower rates.

The Fed remains focused on inflation risks in large part because core inflation is above the 1% to 2% “comfort zone” of many Fed officials, including Chairman Ben Bernanke. In the 12 months through August, core inflation was 2.8%, up from 2.7% in the 12 months through July. Using a lesser-known price index that the Fed prefers, core inflation was 2.4% in the 12 months through July.

Fed officials expect core inflation to move back below 2% over the next two to three years as energy prices stop boosting the prices of other goods and services and the economy cools. If that forecast doesn’t unfold, it could pose a threat to the Fed’s credibility that would require higher interest rates.

The Fed’s continuing concern about inflation seems at odds with investor expectations of rate cuts. Thomas Joseph Marta, fixed income strategist at RBC Capital Markets, says that while the Fed and his own firm’s economists are optimistic the housing slump won’t significantly hurt the rest of the economy, market participants are far more pessimistic. “I’ve heard traders say, ‘Look, the Fed’s wrong,’” he said. “Traders are reacting viscerally to housing. Housing is something you see when you’re driving home from the train station; it’s very obvious, very visible.”

Mr. Marta added, “In terms of inflation, I keep whispering in the traders’ ears, ‘Look, core [prices], hourly wages, unit labor costs, they’re all at dangerous levels.’ They don’t care.”

Still, some economists say the bond market will be proven right. Paul Ashworth, senior U.S. economist at Capital Economics of London, said if housing construction’s share of economic output falls to the same level it hit in the early 1990s, after the last housing boom, “you’ll get a substantial drag on growth.” He expects growth to slow to 1.5% next year from a projected 3.3% this year, and the Fed cutting its rate target to 3.5% by mid-2008.

Another reason for the disconnect could be anticipation of easier credit conditions globally. The U.S. bond market is increasingly linked to its foreign counterparts, and there have been signs of slowing growth in Germany, Japan and China in recent weeks.

 

Email your comments to rjeditor@dowjones.com.

By Maura Webber Sadovi
From The Wall Street Journal Online

Phoenix’s rapidly cooling housing market hasn’t damped the region’s commercial real-estate market. From a new football stadium for the Arizona Cardinals with a design inspired by a desert cactus to more than 16 million square feet of offices, warehouses and retail stores slated to be built in the region this year, the area’s commercial sectors are expanding at a brisk pace amid rising rents and falling vacancy rates.

Some 5.3 million square feet of office buildings are scheduled to be built in the region this year, about double the amount delivered in 2005, according to Property & Portfolio Research Inc., a Boston-based research firm. Meanwhile, some 7.4 million square feet of new retail space is to be delivered this year, up 26% from last year.

The commercial growth has been fueled by a continuing surge in population and employment, says Marshall J. Vest, an economist at the Eller College of Management at the University of Arizona. New arrivals first purchase homes, and now are helping to drive demand for places to shop and work, sending rents higher and triggering more commercial projects that previously didn’t make sense economically, Mr. Vest says. Over the next five years, office, retail, warehouse and apartment rents are all expected to grow at above-average rates, PPR says.

The good times for the commercial sector come as the party is quieting for the residential sector. Until recently, Phoenix has been one of the stars of the nation’s high-flying housing market. The area’s relative affordability, especially in comparison to the pricier California market, has attracted new residents and driven population at an annual rate of 3.3% in recent years — about threefold the national average — to nearly four million people, according to Moody’s Economy.com, a unit of Moody’s Corp.

As interest rates have risen, homes are taking two months to sell, instead of days or weeks, says Mr. Vest. The seasonally adjusted median home price has slipped since the first quarter, and residential building permits fell about 35% on a seasonally adjusted annualized basis in June off the recent peak reached in January, he adds. The downshift comes after the area’s median home prices soared 78% to $272,200 from 2003 through the second quarter, outpacing the 26.2% rise nationally, according to the National Association of Realtors. “It really was a frenzy and that clearly started changing in mid-2005,” says Mr. Vest.

The disconnect between the commercial and residential real-estate cycles isn’t uncommon, in part because institutional investors that help to drive the commercial side are less immediately affected by interest rates. But the housing market and the related jobs in construction and mortgage financing that it generates are a key component of Phoenix’s economy, and some analysts say the economy — and ultimately the commercial market — won’t be able to sustain its current pace as housing decelerates. Already, job growth has slipped to a year-over-year pace of 5.1% in July from 6.5% in July of 2005, according to the Bureau of Labor Statistics. Still, that’s well above the 1.3% national growth rate in July.

“The commercial market is super strong but we do expect the Phoenix market is going to come off of the pure sizzle that it’s had,” says Hessam Nadji, managing director of research for Marcus & Millichap, a commercial investment brokerage firm based in Encino, Calif. One area that appears to be softening is investors’ appetite for apartments purchased for conversion to condos, he adds. Mr. Nadji expects the dollar volume of rental complexes purchased for conversions this year will be lower than the $1.8 billion in 2005.

Some investors remain confident that pure rental apartments stand to benefit from the current residential trends. Rising interest rates and the disparity between the price of for-sale homes and rental housing has increased demand for Phoenix-area apartments, while the strong population growth continues to bring new prospective tenants to the region, says Tom Garbutt, head of TIAA-CREF Global Real Estate, a unit of the New York-based financial services organization. “We’re seeing a lot of people coming back into the rental market,” says Mr. Garbutt. TIAA-CREF recently paid an average per-unit price of about $188,000 for nearly 2,200 Phoenix-area apartments that were part of a larger portfolio purchase.

January 16, 2006 By Edward Leamer UCLA Anderson Forecast (Commentary published in the Los Angeles Business Journal)

In recessions we have negative economic growth, and in recoveries we rack up pluses. But overall, the U.S. economy since 1970 has grown an average of a little more than 3 percent a year.     Don’t expect that for 2006. The Wall Street Journal, in a recent survey of 56 economists, found that their forecasts for 2006 averaged around the “normal” rate of 3 percent. But that is not what the UCLA Anderson Forecast projects. The UCLA Anderson numbers are about 0.5 points less than normal. When the Wall Street Journal ranked the forecasts top to bottom, highest to lowest, UCLA Anderson’s forecast ranks 52nd of 56. What accounts for that difference? Part of the answer depends on our interpretation of the stronger-than normal numbers in 2005 and 2004. Here is my story of the decade: It’s been a roller coaster ride that is ending in 2006. The discovery of the Internet set off a mad dash for the Web, and that powered the U.S. economy forward at breakneck speed from 1997 to 2000. Every business in America had to have a cool Website or advertise on one. There was a very heavy investment in equipment and software. Every person who could crawl off the street was offered a job and anyone who could whisper “yes” was given one. Equity values went into the stratosphere and dot-com workers and their friends celebrated with a wild spending spree. Party favors Reality and reason became unwanted guests at this party in 2001, causing equity values to plummet and jobs to disappear.  But the party picked up again in 2002, when Alan Greenspan arrived with a very attractive bond market nestled on his arm, and passed out party favors inthe form of low-interest loans to compensate for the loss of equity wealth. The low loan rates, reminiscent of the 1950s, set off a mad dash for homeownership that powered the U.S. economy forward at breakneck speed from 2002 to 2005. Every American family had to have a cool house or live next to one. There was heavy investment in new homes and remodeling existing ones. Every person who could crawl off the street was offered a home loan and anyone who could whisper “yes” was given one. Home values went into the stratoshpere and homeowners and their friends celebrated with a wild spending spree. But as the party went on, Mr. Greenspan began to grow worried over the level of debt, and reality and reason returned. In 2006, regulators, worried about delinquencies and defaults, will start to require borrowers to walk off the street (crawling is not enough anymore) and the deals that were premised on continued high rates of appreciation will go sour. Homeowners who can service their debt will cling to their optimism and refuse to sell into a softening market. This tenacity will help keep homes prices from a severe adjustment, but it will make high sales rates of existing homes a thing of the past. Manufacturing question But without the dot-com mania or the housing bubble to power the economy forward, things will slow down considerably in 2006. It could become really ugly really fast in the housing sector if there is a recession with sever job loss, since loss of a job is often enough to force delinquency and default. History suggests this is likely, but history is not a perfect guide. The problem sector in terms of job loss is manufacturing, which alone accounts for 60 percent of job losses. President Bush’s biggest problem in his first term was WMD: the Wicked Manufacturing Decline that occurred during and after the recession of 2001. But sometimes bad things turn out OK. Though there has been no noticeable pickup in jobs in manufacturing, it is also true there just aren’t that many more jobs to lose. Thus the good news: The softening of the economy because of problems in housing cannot be amplified in the way that it had been historically with major job losses in manufacturing. Without that amplification, we cannot have enough job loss to have a recession. In other words, rather than a sharp correction, 2006 begins an adjustment that is little-by-little, lasting several years instead of just one. There won’t be as much cocktail chatter about how much we are making on our homes, but like the frog in hot water, we otherwise will notice - provided that foreign lenders who have been financing a $700 billion gap between U.S. earnings and U.S. spending do not start to worry about the U.S. economy and begin to look elsewhere. That could be where the next recession gets started, though we have never had one in the U.S. that has its roots in an external deficit.