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February 2011 Real Estate Insights: “Changing Times”

Already this new year we have seen changing patterns: in weather, in politics, in international developments. We’ve also seen changes in factors affecting real estate, as well as a change in the influence of housing on an economic recovery. In his Real Estate Insights commentary this month, NAR Chief Economist Lawrence Yun looks at a variety of developments, both domestically and overseas, and how those changes could impact housing going forward.

We’re one month (and some) into 2011, and it’s already been an interesting new year. Enough snow to shut down Chicago (Chicago!) and New England, ice, “wizard of Oz” type cyclones (“It’s a twister”) and floods in Australia. The good news is that such weather-related phenomena will abate when Spring finally arrives (and it will).

As far as the economy and housing, the climate has also been somewhat other than temperate. Mortgage rates have already jumped from their exceptionally low rates of last year, and are likely to rise even further. Of course, we expected mortgage rates to increase – that is not unusual as an economy comes out of recession and is in recovery.

But another reason underlying additional upticks in interest rates is the situation in Egypt and other countries in the Near and Middle east regions. As I am writing this column, Egyptians are “on the march” – whether for or against their current political leadership. For better or worse, the tipping point for that most ancient of civilized nations is past and the country will undergo significant changes.

Why should those of us in the U.S. care? After all, Egypt is not a major oil-producing country. But Egypt’s neighboring countries are. The reigning regimes in those nations – including Saudi Arabia — have had a similarly tight but potentially shaky hold on power and that could impact the price and supply of oil. Oil prices not surprisingly surged above the $100 mark recently. Because of that, there will be additional worldwide inflationary pressure and a consequent need to charge higher interest rates to compensate for loss in purchasing power of money. For the U.S, that means each $10 increase in oil prices will result in Americans needing to fork over an additional $220 million each day for oil consumption. Those funds mostly will go to foreign oil-producing countries. Not into the U.S. economy.

Still, we are so close. One component that has contributed to – and is expected to contribute to – broader economic growth is higher U.S. exports. Chinese and Brazilians will buy more U.S. products as global economic momentum gathers. U.S. exports will rise – believe it. Indeed, the most recent report on GDP from the Bureau of Economic Analysis indicates that one of the major contributors to the 3.2% GDP growth rate in the 4th quarter of 2010 was an increase in exports (and a decline in imports).

But that was then. Going forward we should be mindful that imports will rise. Improvement in net exports, partly in light of the situation in Egypt, will be muted because of the higher cost due to increased costs for imported oil. Don’t look for any meaningful changes in net exports; rather, expect continued large U.S. trade deficits as long as oil prices remain high.

The other components of economic growth do not bode well for a fast recovery either. Post-mid-year election “tea party” energy will hold back growth in federal government spending. Local and state governments, both of which (in most jurisdictions) have to balance their budgets, simply don’t have the money to spend (and we haven’t even gotten to the cost of snow removal in the major metros). In the long run, a smaller government can help with long-term entrepreneurial-driven economic growth. But in the short run, less government spending will mean less hiring for highway construction workers and a lower amount going into dwindling unemployment checks.

We could also see a type of consumer malaise. The economy may not be able to rely heavily on those consumers with stable jobs to help with economic recovery. Yes, a solid stock market recovery has lifted wealth for some, but many consumers historically have relied on the wealth tied to their housing equity for comfort. They are now staring at a much lower household net worth in the aftermath of a painful housing market bust. Furthermore, homeowners who refinanced last year into historically low rates interestingly brought more cash to the table and thus lowered their overall mortgage debt, perhaps to swim out from underwater status. The lowering of debt is a healthy trend for the long-haul, but it also means less money available for current spending and current economic growth.

Historically, the housing market has been a major power engine for economic growth, particularly coming out of a recession. But not this time. Additional foreclosures and shadow inventory loom. Many homebuilders know their product cannot compete with the deeply discounted distressed property sales. In fact, there are some homebuilders who believe their products are not a substitute to distressed properties and so are willing to take risk and test the market. However, they are being held back by very tight terms for construction loans. As a result housing starts will be lucky to scratch out 700,000 units in 2011 – half the normal historical annual production, though an improvement from the 554,000 and 586,000 starts, respectively, in the past two years. That implies little addition to economic growth. It also implies a faster “cleaning up” of what has been a bloated housing inventory, particularly as existing-home sales pick up. And note: existing homes offer a far more attractive deal to home buyers than do newly constructed homes. Since jobs are now being created, albeit at a slower than desired rate, existing-home sales will likely see some improvement in 2011. Changes in median home prices will be determined by how fast the inventory is worked off. Assuming that the pace of home sales can hold at near 5.2 million units, as occurred in the final month of last year (with swings in home sales induced from the existence and absence of the homebuyer tax credit largely over), then the inventory absorption rate will be such so as to large keep home values broadly stable. The lack of builder activity has resulted in a 40-year low on newly constructed inventory, which will help offset some of the distressed shadow inventory that will be reaching the market. For REALTORS®, rising sales – but non-falling prices – will finally mean some improvement in their bottom line in 2011.

One sector that could really help with economic recovery is the business sector. Large companies in particular are flush with cash. Profits have been rising robustly, and that has contributed nicely to stock market gains. Business spending, however, has not ramped up commensurately with increases in corporate profits. Some hold-back was related to extra regulatory burdens coming out of Washington. But a new temporary tax incentive on expensing business costs right away in 2011 rather than depreciating over many future years will force companies to unload some of their cash holdings this year.

The aggregate impact of international trade, government spending, housing, consumer spending, and business spending is that the economy will grow sufficiently to generate about 2 million jobs in 2011. That is an improvement from the almost one million job additions in 2010. Expect local housing market recovery paths in terms of both sales and prices to follow in the footsteps of local job market conditions. Those metros with reasonably healthy job creating markets have so far been Washington, D.C., Boston, Minneapolis, and Seattle. The local economies with energy exposures such as those of Alaska, North Dakota, Oklahoma, and Texas are also doing relatively well. (Internationally, Norway stands out with budget surpluses resulting from heavy oil production in an otherwise European market of budget deficits and near bankruptcies among industrialized countries).

Yes, homeowner wealth has declined. The median net worth – the value of everything owned minus everything owed – for a homeowner is estimated to have fallen from $230,000 in 2007 to about $170,000 in 2010. But the net worth of homeowners still outpaces that of a typical renter: $4,000 to $5,000. That is a testament to long-term benefits for people who steadily pay down mortgage.

Aside from the eventual financial benefits gained over many years for homeowners, let’s not lose sight of the intangible societal benefits of homeownership: better communities, higher civic participation, lower juvenile delinquencies, higher pupil test scores and higher voter participation rates among home-owning families versus tenant (rental) households. The turmoil in Egypt and elsewhere in the Near and Middle East has no doubt brought to light numerous political and societal causes of that turmoil (including lack of full democratic participatory rights for citizens and a quite sizable number of people without clear land rights). We should still consider the intangible social stability those results from having a super majority population that are property owners. I’m not suggesting that homeownership will cure society’s ills, or cure political unrest in the Near and Middle East. But the U.S. has seen the benefits of a homeownership populace and private property rights that are embedded in our Constitution. President Thomas Jefferson dreamed of a well-functioning and self-governing democratic society evolving from a nation of agrarian land-owning families. During the World War II era, President Franklin Delano Roosevelt said that a nation of homeowners is unconquerable. President Ronald Reagan advocated the need to preserve one important aspect of the American Dream – homeownership – which the mortgage interest deduction symbolizes.

The idea of homeownership has been attacked from many quarters because of the housing bubble and subsequent bust. Many mistakes were made during the cycle. However, as the country takes a critical look at federal housing policy, let’s not lose sight of the immense intangible value of homeownership –sustainable homeownership – to our country.

This commentary is taken from the February 2011 edition of Real Estate Insights. To read the full February Issue of REI, click here.

Lawrence Yun, PhD., Chief Economist and Senior Vice President

Lawrence Yun is Chief Economist and Senior Vice President of Research at NAR. He directs research activity for the association and regularly provides commentary on real estate market trends for its 1 million REALTOR® members.

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