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2015 Economic Outlook: Is Arizona's Groundhog Day finally over?

For the past six years, experts from the W. P. Carey School of Business have been forecasting the same thing about the Arizona economy: slow recovery. But 2015 just might be the year that we can declare Arizona’s economy officially, finally, recovered.

2015-05-06

Listen to Lee McPheter’s speech:

Listen to Michael Orr’s speech:

Listen to Dennis Hoffman’s speech:

For the past six years, experts from the W. P. Carey School of Business have been talking about the slow economic recovery in Arizona. Their presentations at the annual Economic Outlook Luncheon, sponsored by the W. P. Carey School of Business' Economic Club of Phoenix, have been reminiscent of the movie Groundhog Day, offering the same outlook year after year. Arizona was always recovering, but not recovered.

Until now. 2015 just might be the year that we can declare Arizona’s economy officially, finally, recovered. “The economy has finally gained traction,” says Dennis Hoffman, director of the L. William Seidman Research Institute at the W. P. Carey School. “We’re in a much different place than a year ago. Now we’re seeing true signs of life in the economy.” The signs of life include growth in jobs, wages, and state revenue and a return to normal real estate demand.

The state still faces significant challenges, however, among them job quality and per capita income, which is why Lee McPheters, director of the JPMorgan Chase Economic Outlook Center, called for just “two cheers” for Arizona’s economy.

Michael Orr, director of the Center for Real Estate Theory and Practice, joined Hoffman and McPheters on the podium to deliver his analysis of the central Arizona real estate market, which is also in a different place today than it was a year ago.

Employment is growing

Arizona ranked 14th among all states in job growth rate in March, with 2.6 percent growth compared to the previous year. McPheters points out that Arizona’s neighbors — all except New Mexico, Montana and Wyoming — are faring better in terms of job growth. Seven of the country’s top 10 job growth states are in the West.

That, says Hoffman, is positive for Arizona. “The biggest positive for Arizona is good economic news from other Western states. There are spillovers from our neighbors. Arizona businesses do better, and the state does better.”

If Arizona keeps adding jobs at the current pace, by the end of the year the state will have regained all the jobs that were lost during the recession. “Between the peak in October 2007 and the bottom in September 2010, Arizona’s economy lost 313,000 jobs,” McPheters explains. “So far we’ve regained 245,000 jobs, so we still have to gain 68,000 more jobs to be at the same level of employment as we were before the recession.” The consensus forecast calls for 66,700 new jobs in Arizona this year.

Almost all of that job growth (99 percent) is in services industries — including professional services, health care, leisure and hospitality and finance and insurance. While employment has grown 2.6 percent overall, the rate of growth in “other services” jobs — personal, laundry and repair services for consumers — was 8.2 percent. Growth in construction jobs was just 1.5 percent.

Income is growing (sort of)

Many of those fast-growing services industries pay relatively low wages. And consumer services don’t bring dollars from outside Arizona into the state, like exporting does. Both factors limit economic growth potential.

Arizona ranked 18th in personal income growth rate in 2014, but the state was 41st overall in per capita income. “That is an emerging problem,” says McPheters. “Job quality is the greatest long-term risk to Arizona’s economy.”

McPheters explains, “One measure of economic prosperity is per capita personal income. The only way to raise that is to have a higher number of jobs that pay above average. Arizona doesn’t have to be in the top 10, but the state should be in the middle of the pack with regard to this indicator. Not in the bottom 10.”

State revenues are growing

Real income, which takes inflation into account, is on a long downward trend in Arizona and across the nation. In 2001 real median household income in Arizona was $56,200; by 2013, it was $50,600.

But in recent years income has risen from below $48,000 in 2012. At the same time, revenue into the state coffers has risen too. The state brought in $596 million in individual income tax payments in April this year, up from $503 million in 2014 and the highest level since 2008.

“Improved state revenue is a good sign the economy is improving,” explains Hoffman. “2014 was so disappointing — it was an anomaly — but this year we’re back to a normal trajectory.”

The real estate market is stabilizing

Real estate has long been a driver of Arizona’s economy. Indeed, slow growth in construction activity has held the economy back. But there is plenty of reason to be optimistic about the real estate market, according to Orr.

“Optimism is the order of the day,” Orr says. “Homeowners are paying their mortgages, the quality of outstanding debt has improved, mortgages are relatively affordable, lending standards are loosening, demand is normal and stable. The market is in much better shape.”

Indeed, homes sales were up 17 percent in March 2015 compared to the previous year. “Overall demand is back to normal,” explains Orr, meaning that the number of buyers in the market is at a normal (non-boom, non-bust) level.”

“Sales are up significantly from last year but last year was really poor. Demand isn’t rocketing away,” Orr explains. “Some people feel like the sellers are in charge in the market — fielding multiple offers, for example — but that is not because of too strong demand.”

Instead, it is because of too weak supply. “Most people don’t realize how low supply is,” says Orr. “The supply of new homes is still only about one-third of normal. We won’t be back to normal levels of new home construction anytime soon.”

Supply constraints are particularly acute at the entry level (homes below $200,000), Orr says. The supply of homes on the market is about 79 percent of what could be considered normal; supply of entry-level homes is just 45 percent of normal. “There is a chronic supply shortage in that segment of the market.” That will cause prices to rise faster for those homes, potentially making affordability an issue, Orr says.

The reason for the supply shortage is that the industry underbuilt entry-level homes, explains Orr. “There are plenty of homes available at the middle and upper end of the market, because that’s where builders make more profit.” The same is true in the multi-family real estate market. “There are many more luxury apartments available than lower-priced ones.”

But …

While Hoffman, McPheters, and Orr are all optimistic about Arizona’s economy — much more so than any other time in the past six years — there are still risks.

For one, the fed is in a “challenging position,” says Hoffman. “The fed wants to raise interest rates to get back to a more normal trajectory. But they’re afraid of choking the economic expansion, of shocking markets and sending the value of the U.S. dollar higher.”

The value of the dollar has risen substantially lately, and that weakens U.S. exports as they become relatively more expensive in world markets. “The last thing we need right now is a stronger dollar,” Hoffman says. “The U.S. economy is estimated to have grown just 0.2 percent in the first quarter, compared to 2.4 percent on average in previous quarters. The weakness was due in large part to weak exports. And exports were weak because of the strong dollar.”

On the other hand, Hoffman explains, the fed has signaled to the market that interest rate hikes are coming. “Some people say that the fed has to follow through and raise interest rates or else it will breed uncertainty, which markets hate.” At the end of the day, Hoffman says the fed has been one of the few government functions that has worked really well. “They succeeded in stimulating the economy. But getting out of it is always tough.”

Another risk: despite all the good news, consumers remain cautious. “For the past 40 years at least, consumer spending has grown 3.5 percent on average. But in this recovery, the growth in consumer spending has averaged 2.5 percent. Consumers are not running at full speed,” explains McPheters.

Perhaps 2015 is the year that will change. Two cheers, McPheters says, for Arizona.

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