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Predicting Arizona's 2024 economy

ASU experts say it will be a weak 2023-24 economy, but they don't see any crisis or collapse.

2023-05-02

Arizona's economy flourished in 2022, but it will be weak in the second half of 2023, and the first half of 2024 will be weaker, according to ASU economists.

"We are anticipating job growth to take a nosedive," said Lee McPheters, research professor of economics and director of the JPMorgan Chase Economic Outlook Center. He spoke at the Annual Economic Outlook luncheon hosted by the Economic Club of Phoenix.

McPheters predicted that 100,000 new jobs would be added in Arizona in 2022 when, actually, 124,000 jobs were added. Arizona was 12th in the nation for job creation.

The job growth is mainly in health care, adding one-fourth of all new jobs. Five sectors of the Arizona economy account for three-fourths of all new jobs, including health services, hospitality, professional technical services, manufacturing, and wholesale trade.

McPheters explained that we'd see the shedding of jobs in the second half of 2023 when the tight monetary policy begins to bite the economy.

When Fed policy hits, we're going to see a real dropping off in employment, going down from that 124,000 new job level to something in the range of 55,000, maybe 60,000 jobs. That will persist for the next couple of years, he said.

McPheters talked historically about Arizona's economy and how the state lost jobs in 2020 but was No. 1 in the country in job creation in 2019.

"We're talking about an economy that has the potential to be a top-five job-growth economy. But we're not seeing that for 2023 and 2024," he said. "We expect we will be closer to the middle of the pack, maybe 15th to 20th in terms of where this economy ranks overall."

When interest rates begin to be cut in the first half of 2024, McPheters said they expect the economy to return. But whether there's a recession in the mix remains to be seen, according to McPheters.

"We've had a recession watch for over a year and a half. To have a recession, you need to have a lot of unemployment. Those things go hand in hand," he said.

McPheters pointed to our average quarterly unemployment numbers, which are the lowest in 50 years at the national level. Arizona has the lowest unemployment numbers it's ever had at 3.5%.

McPheters said, If you're going to say there's a recession around the corner, you've got to see a massive increase in unemployment and, month to month, we get those numbers. It will be interesting to see if that changes our population forecast," he said.

Arizona came in eighth in population growth in 2022, and Florida was No. 1. McPheters said the Southeast and the Mountain West are where most of the population growth is going and has been for the past five decades, probably because of the more pleasant climates. McPheters said they predict over 100,000 new Arizona residents in 2024.

The 2022 population numbers found that 18 states lost population. How can that be?

"They are moving to other states because of the work-at-home phenomenon, because of the influence of the pandemic, perhaps changing people's perception about where they want to live and what they want their life to be like," McPheters said.

Maricopa County is No. 1 in absolute population growth across the U.S. Other counties with high population growth are Texas and Florida.

Switching over to the outlook for metro Phoenix, McPheters said they expect about 44,000 jobs this year, slightly more than in the year ahead. They're also expecting the same kind of dip in single-family housing, down to around 20,000 single-family permits in 2023, and there will be a modest comeback in 2024.

"We have some issues in Phoenix that, as an economy and as taxpayers and citizens, we need to deal with," said McPheters, referring to the state's consumer price index (CPI), driven by rising gasoline prices.

Housing is an essential component of the CPI, at 8.5% in Phoenix.

"The Phoenix CPI is the highest of any metropolitan area, and we're expecting that to continue," McPheters said. "Meanwhile, wage increases are about 5%. Therefore, when your inflation rate is 8.5% and your wage increases by 5%, your real income is declining. That affects the general attitude about the economy and perception of whether conditions are good."

Why are these prices so high? McPheters said it's a mix. The requirements for pollution control are stricter in Arizona, which tends to drive up gas prices.

McPheters also warned of Phoenix's rising housing prices.

"We've lost the label that Phoenix has affordable housing compared to the U.S. average," said McPheters. "Affordability has deteriorated for Phoenix, and we are in a situation where we have a social issue developing."

"On the recession front, Dennis Hoffman agreed with McPheters, with a caveat.

"In no recession has the unemployment rate remained below 5%. So, if we're going to have a recession, it's about unemployment rates rising from here," said Hoffman, director of ASU's Office of the University Economist and the director of the L. William Seidman Research Institute.

Hoffman said they got a signal that job openings have plummeted over the past few months.

"Higher unemployment rates may be on the horizon," he said. Many pundits expect less than 200,000 jobs each month going forward."

Hoffman said forecasters see even worse conditions in 2024 than they're forecasting in 2023.

"The top 20% of the forecasters think next year unemployment rates will eclipse 5%," he said.

Hoffman discussed several current and potential problems.

He discussed that the high gas prices in the Valley aren't typical. He said that typically Phoenix prices spike when Los Angeles prices do because we get some fuel from LA refineries. They also spike in the spring when we're doing blend conversions.

"This ramp-up over the past two months has been unprecedented," he said. "There are problems with refineries in West Texas, which explains why Tucson's gas price is up. It's not a metro or blending issue. We don't have enough refineries. If you want cheap gas, you need a refinery in your backyard."

Consumer sentiment has risen, but Hoffman wonders if it will hold up.

"The markets are having a tough day today. This bank fallout and runs on small regional banks are a concern," he said.

Hoffman finds it interesting that consumers held up, thanks in no small part to seniors.

"People 55 and over account for 41% of total consumer spending, and 21% of it is seniors 65 and over," he said.

But credit card debt is also rising, and those interest rates are higher, according to Hoffman.

"Credit card debt is on the rise, showing that the consumer is working in full force," he said.

What are the implications of a Silicon Valley disintermediation? Hoffman said it could be a credit crunch but is sure of more regulation even though it's unclear that that was the problem.

"Regulators have the law but didn't act," he said. More likely, a slowdown and a soft-landing scenario come into play when you think about Silicon Valley."

The question on everyone's mind is still, "Will we have a recession?" Hoffman asked.

"It will be mild, especially in Arizona," he continued. "Strength of the labor market will be a determining factor, and if unemployment rates stay below 5%, it can't be bad."

Hoffman said there's a 50% chance for a soft-landing scenario with little or no growth.

The most likely scenario is a soft-landing scenario where we get little or no growth in quarter two, negative growth in quarter three, and come out of it with slow growth. Into 2024, there will be slow growth, but not negative.

So, what will determine the severity of the downturn? Hoffman said it would be determined by the length of the Fed tightening, the health of the consumer, and housing.

"I call it bank contagion," he said. "Will there be a fallout from Silicon Valley's collapse, or maybe some other shocks?"

Hoffman left the audience to ponder other shocks, including black swans, the Taiwan invasion, the war in Ukraine, oil, gas, energy, weather, earthquakes, and the debt ceiling debate.

Transitioning to housing, Hoffman said real housing held up.

"The consensus forecast that I've found suggests that we'll have slower housing transactions, but not a collapse in housing as we had going from '04, '05, and down to '07 and '08," he said.

COVID-19 and several fits and starts in the economy are affecting the real estate marketplace, according to Mark Stapp, the Fred E. Taylor Professor in Real Estate.

Pre-pandemic, the median price of a home in Phoenix was $295,000, and there were only a little more than two months of inventory. In June 2022, after mortgage rates started to increase substantially, the median price of a home was $475,000, and there were three months of inventory. March 2022 showed the lowest inventory rate, just before rates started to go up, with nine months of inventory.

"That's a horrible inventory level," Stapp said. "It's a basic supply-demand issue."

Interest rates started to have an effect, pushing the inventory up, Stapp explained. But as interest rates have come back down again, the inventory has dropped. The total inventory of homes in March 2022 was a little more than 8,000 units, and now it's up to 16,922.

"I suspect inventory will come down again," Stapp said. "Lack of supply starts to push up because demand increases for various reasons."

One of those reasons is that increasing interest rates influence housing affordability, said Stapp.

"Only 18% of our population can afford a median-priced home here," he said. "That's a meager number. The problem is that there are not enough homes at the median-price level and below to accommodate many of the kinds of jobs we're getting here, causing this affordability problem."

Also, Stapp explained that if people can't afford a home, they begin looking for alternatives further out from their employment.

"The tradeoff is that they have to drive further to get to work, and if gas prices keep going up, it even more greatly impacts the affordability of things in life," he said.

Stapp said Arizona has underbuilt single-family and multi-family housing for 12 years.

"We're far below the average," he said, "and real estate can't snap back. It takes a long time to add new inventory to the market. When you get these whipsaw responses — policy, inflation rates, the pandemic, and other things — it creates these fits and starts in the market. Then it's hard for the decision makers to choose when to continue adding or start adding."

According to Stapp, only 20% of the homes being constructed are at or below medium prices. Labor, material costs, land prices, and regulatory issues affect housing pricing, too.

Stapp said there was a big jump in the number of units permitted from 2019 to 2022 and a significant increase in construction.

"People don't start living in those units for maybe three years," Stapp said. "Building some of these multifamily homes takes 18 months to two years. You're deciding today, and you're not seeing the effect of it for many years. Then when the market begins to change after you've made that decision, you see some ramifications."

As those units are being added to today's marketplace, those rents are softening slightly, he said.

Switching to industrial, Stapp said a great employment market drives population growth, and population growth drives housing demand.

"When you look at the industrial market, there was probably no better market in the United States for an industrial broker than in Arizona," said Stapp. "It's been a phenomenal run for the industrial market. There was a tremendous amount of warehouse and distribution space, and manufacturing, advanced manufacturing, and light manufacturing have returned significantly to this marketplace."

Stapp said we've been absorbing more than we were building in industrial space over a long period, keeping the vacancy rates down. He said a tremendous amount of space is being added to the market to meet the demand. He said there are 332 million square feet of total existing industrial supply currently in the market.

In the first quarter of 2023, 4 million square feet of space have been added, and vacancy rates are exceptionally low (2.7%). Over the next 18 to 24 months, 45.8 million square feet are being built.

"Industrial land here is $12 to $15 per square foot compared to our competitive alternatives, which is Las Vegas and Southern California, where they are at $30 and $60 to $150 a square foot for the same kind of building space or land. So, Arizona is attractive, and that will continue to bode well for us," Stapp said.

He said it's interesting that there's a 180-degree difference in office space from industrial.

A recent Gallup poll that Stapp referred to found that only 7% of people prefer to work in the office full-time.

That's why our vacancy rates are so high," he said. "We've historically had about a 21% vacancy rate in offices."

Stapp said that 10 years ago, he wouldn't have said retail is one of the darlings.

"Over the past 10 years, retail has quietly and slowly performed extremely well," said Stapp. "It's the same thing: we absorbed more than we were building. That has caused vacancy rates to fall and asking rents to rise."

Stapp said part of that is because we took a lot out of the marketplace during the pandemic that shouldn't have been in it.

"We didn't build a whole lot of new inventory, but we continue to have population growth, and we continue to have population growth that required retail services," said Stapp.

He said we're returning to providing the space to offer the services to live everyday life, such as grocery and nail and hair salons.

He echoed Hoffman's concerns about the three bank runs that had to be taken over by the Feds but doesn't believe it will have a contagion effect. Another problem he debunked is that we'll have another housing crisis.

"When you look at the distribution of commercial real estate loans amongst the various institutions, you see that only 38% of it is in banks, he said. "The No. 1 concern isn't the big banks. The big concern is the community banks, the ones least able to absorb some of the downturn."

Stapp also noted that lending has tightened up and that we last had this lower volume in collateralized mortgage-backed securities funding in 2009.

"That's an indication of the concern the credit crunch is having on the overall marketplace," he explained. "So, here's what is happening. Retail rate hikes create fear. We're adding new space to meet the demand, which is becoming more challenging because of this credit crunch."

Stapp summed up his presentation with his forecast.

"Employment growth continues to drive population growth, which drives our demand for housing," Stapp said. "At the same time, industrial demand remains strong, and I think it will continue to be strong."

Still, Stapp said it's hard to add new housing because supply remains extremely low, and it will be hard to add new supply for various reasons.

Home prices will continue to rise because of this, but we don't have a plummeting housing market.

Stapp said retail will follow rooftops, which means we all have a stake in building dynamic, accessible communities.

"Multifamily underwriting slows dramatically exactly when we need it to continue to add supply to the market," said Stapp. "Two years from now, we're going to be back in the same situation we were at the beginning of this year."

Stapp said he's concerned about increasing supply, softening prices, and credit slowing new growth.

We're not going to be able to add the amount of inventory that we need to support the population growth we're predicted to have if there's a credit crunch," Stapp said. "That's going to cause a greater affordability problem for us, and that's going to create more homelessness, which doesn't help the situation."

Stapp said we also have a conflict between growth patterns in water issues where most of the growth will occur between now and 2040 — the West Valley and Pinal County.

"Those two areas where growth is going to occur are the areas where we have the greatest concern over a short hundred-year water supply," he said. "It's going to cause a change in development patterns. Capital markets are going to slow all their underwriting."

Top photo from left: Mark Stapp, Fred E. Taylor Professor in Real Estate and executive director of Arizona State University's Master of Real Estate Development program; Lee McPheters, research professor of economics and director of the JPMorgan Chase Economic Outlook Center; and Dennis Hoffman, director of the L. William Seidman Research Institute at the W. P. Carey School of Business and director of ASU's Office of the University Economist. Photo by Charlie Leight/ASU Now

Economic Club of Phoenix