Back to the 80s: Are we in for a real estate repeat?
The amenities of desert living have long brought a strong inflow of new residents to Arizona, which is good for the real estate market but bad for institutional memory: Those who have not lived very long in the Grand Canyon State might not know about the great real estate downturn of the late 1980s and early '90s. As the state and national real estate boom (some call it a bubble or a balloon) fueled by the low-interest policy of the Federal Reserve 2001-2004 cools off, investors, homebuyers and real estate professionals with long memories may be wondering if the approximately four-year plunge of 1987-91 is about to repeat.
The amenities of desert living have long brought a strong inflow of new residents to Arizona, which is good for the real estate market but bad for institutional memory: Those who have not lived very long in the Grand Canyon State might not know about the great real estate downturn of the late 1980s and early '90s. Arizona recovered from those rough years — which saw large drop-offs in home prices, construction, construction employment, rental occupancy rates, land prices and a host of other indicators.
As the state and national real estate boom (some call it a bubble or a balloon) fueled by the low-interest policy of the Federal Reserve 2001-2004 cools off, investors, homebuyers and real estate professionals with long memories may be wondering if the approximately four-year plunge of 1987-91 is about to repeat.
Experts at the W. P. Carey School of Business advise some caution. But even though prices still are rising, a repeat of the '87-91 plunge is very unlikely because of a number of factors, they say, and Arizona will fare better than the rest of the nation in the next few years.
No comparison
Lee McPheters, professor of economics and senior associate dean of the W. P. Carey School of Business, provides perspective and background by pointing to Phoenix resale home prices, which rose through the early and mid-1980s before values fell. "Average single-family home prices peaked in the first quarter of 1987 at $93,000," he says.
"Prices fell by 7.5 percent between 1987 and a low point in the fourth quarter of 1990 at $86,000, so it was a four-year downturn in appreciation. Prices gradually rose after that and returned to the $93,000 mark in the fourth quarter of 1993." The number of housing permits fell for four years in a row (1987-91), but after the 1991 recession, the number increased by double-digit percentages each of the next four years, McPheters notes.
So far, the current cooling-off does not begin to compare to the '87-91 fall. "As of now in the current slowdown, median single-family resale home prices have not fallen," McPheters says. "Median sales prices in the metro Phoenix area are still about 2 percent higher than last year at this time." Arizona real estate is expected to do better than the rest of the nation.
"On a relative basis, the Arizona housing market is still doing better than the national market and I expect Arizona to fare better than the rest of the nation, all other things remaining equal," says Crocker Liu, the new McCord Chair in Real Estate at W. P. Carey. "The big concern is with the economic base, since it is driven by companies such as Intel. If these companies start laying off workers, then the question is how many. It is these large companies that drive the economy."
Liu says population growth will buoy Arizona real estate, especially moderately priced homes. "Although I haven't spent enough time in Arizona, having just recently moved here, my suspicion is that we have a bifurcated market: the market for the over $1 million dollar houses and those that are more affordable, say $350,000 to $500,000," Liu says. "I suspect that the former market is going to be a lot softer than the more affordable houses because people are still moving into Arizona, given its favorable economy, at a more rapid clip than the rest of the nation."
"Arizona will sustain a strong real estate market over the longer term due to its population growth," says Dennis Hoffman, professor of economics and associate dean for research and doctoral programs at the L. William Seidman Research Institute. "However, it is indeed a cyclical industry. We appear poised to experience a downturn that may take several years to play out."
A unique case
What factors, then and now, are unique to Arizona? "The Arizona downturn in the 1980s was due to changes in the tax laws and the S&L crisis which undercut the local real estate market," McPheters says. "Between 1987 and 1992, construction jobs fell by 25 percent and about 30,000 jobs were lost in construction. Housing prices were weak, land prices fell.
Arizona was harder hit because construction at that time accounted for more than 8 percent of all jobs, compared to about 5 percent at the national level." Current Arizona job growth is more robust than the nation's, McPheters says, but had slowed down in the late 1980s. "Arizona went from being one of the top growth states to being among the bottom 10 by the late 1980s," McPheters says.
"The employment picture is different between the 1980s and now; at least in the short run, Arizona is one of the top five states for job creation, and job growth supports the housing market." Also, mortgage rates in the 1980s were around 10 percent but now are in the 6 to 7 percent range. And, the cyclical nature of real estate is related to population cycles, even in a state like Arizona that is so attractive to move into.
"Arizona always grows more rapidly than the nation, about 3 percent vs. 1 percent a year," McPheters says. "There were peaks in growth about every 10 years: 1985, 1995, 2005. So one similarity with the 1980s is that population growth is very strong in Arizona but it appears to have peaked and will be a bit slower in the next couple of years, which should affect housing demand."
The W. P. Carey experts say the recent moderation in prices simply represents a return to a "normal" market. "Both population growth and job creation in Arizona are currently three times the national average, and that can support a 'normal' level of housing activity," Hoffman says. "As long as population growth and job growth continue, the market will not collapse. However, there is a record level of inventory of new and resale homes that will need to be worked off."
According to Hoffman, Arizona historically has been a homebuyer's bargain but the last few years' acceleration in prices has eliminated some of the state's competitive advantage. "Still, I don't see much abatement in the North-to-South migration that Arizona has enjoyed for decades," Hoffman says, "and as prospects for manufacturing employment in the Midwest continue to deteriorate, this tendency to migrate to the Southwest may actually increase."
The run up is over
Where does this leave the average homeowner? "The run-up in prices is over," McPheters says. "If you want to sell your home, you need to recognize that there are 45,000 residential properties for sale in the metro Phoenix area right now, four times the number one year ago at this time. Most sellers are getting 95 to 98 percent of asking price and are happy to get it." "Expect softening to occur but it's worse on a national level," Liu says.
"Also, more softening is expected on the higher end, pricier homes vs. more affordable homes." One factor that has kept prices up is real estate "flipping" — investors buying properties and then putting them up for sale at higher prices. The experts say flipping constituted between 20 percent and 35 percent of the Phoenix area's real estate activity in the past year or two. What is the overall forecast for Arizona real estate?
"Stagnant prices for several years," Hoffman says, "Coupled with sharp declines in starts and resales for the current year, then very slow growth in transactions for the next year." "There is a huge inventory to choose from, and there will be room for negotiation," McPheters says. "But don't expect to find prices significantly below 2005 levels." "Think twice about going into a deal if your goal is merely to flip real estate," Liu advises.
"In the long run, Arizona property is a good investment, but real estate is cyclical and the current peak has been passed. Expect to wait a few years before seeing anymore big gains," McPheters says. "There are a lot of listings, and sales are off by about one-third compared to one year ago. But even so, 2006 appears to be shaping up as perhaps the fourth- or fifth-best year ever for Arizona housing."
For now, a long-term view is better than a short-term view. "In the 1980s, there was heavy speculation on land west of Phoenix," McPheters says. "That land is now being developed some 20 years later, and those who stuck with the far East Valley and West Valley vision for growth are finally seeing the benefits."
Bottom line:
- Arizona's economy and real estate market are faring better than the rest of the nation, and that trend is most probably will continue, so a repeat of the 1987-91 slump is very unlikely.
- Homeowners wishing to sell will have to wait a bit longer to close a deal and perhaps settle for slightly less than their asking price.
- Home buyers enjoy more choices and softening prices but face higher interest rates.
- Real estate professionals face a drop in activity from recent years' frenzy but still can enjoy a good year by historical standards.
- Investors, after years of short-term bonanzas, are advised to think more about the long term.
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