Sweet Orange

Which of these competing statement about the housing market do you think is true?

During the housing boom, homeowners had no qualms about spending money to commute to distant suburbs carved out of the hinterlands. But frugal home buyers, [Economist Edward Leamer, director of the UCLA Anderson Forecast] said, will be more inclined to look first at homes that are closer to their jobs.

“We’re going to see more multifamily-dwelling units,” Leamer said.

The real estate industry is known for its bigger-is-better attitude, but even some industry pros sense a change.

“We’ll probably be seeing a trend toward smaller, greener, less-costly-to-maintain houses,” said Walter Maloney, spokesman for the National Assn. of Realtors. It’s “a return to basics.”

OR

“People have short memories and just look a couple years ahead,” said San Fernando Valley real estate agent Gary Rapoport, who represents clients generally looking for properties in the $400,000 range. “They just want to buy whether they qualify or not.”

Real estate economist Christopher Thornberg seconds that view. Californians display a sort of amnesia about downturns that affect the housing market, he said, whether caused by financial-market debacles or the collapse of the technology boom. Price slumps in each of the last four decades, he noted, didn’t dispel the perception of residential real estate as a sure-bet investment.

“We’ve been here before,” Thornberg said. “People have a shocking ability to forget the past.”–Chris Jacobs, The Los Angeles Times, “Recession may forge a shift in California housing

Next week I will take another look at this topic and provide a third option.

Here are some observations on the economy that Chris Thornberg, a principal with Beacon Economics, made during one of his visits to AirTalk. What do you think? He hit the nail on the head?  Or he missed the mark?

• Foreclosures will remain high next year.
• The stock market is the ultimate “drama queen” when it comes to predicting the direction that the economy will trend and, therefore, is not a good economic indicator. (Michael Murphy at Seeking Alpha thinks otherwise, but that’s for another time.)
• An increase in exports is needed if the U.S. economy is to improve. Therefore, the world economy must improve so that we have somewhere to send our exports.
• Although many believe that the root of our economic problems was the housing market collapse, Thornberg says that is a symptom, not the root problem. He states that the root of the problem was that we were spending more than we made. Thornberg further states that debt is what we used to fund this spending beyond our incomes. Note: According to the Federal Reserve, we were spending 127% of our personal income in 2005. Obviously, not a sustainable amount.

Chris Thornberg, a principal with Beacon Economics, had some comments on what the leading and lagging indicators of market recovery will be for this recession (AirTalk, Larry Mantle, August 7, 2009). (By the way, Tim Quinlan, a Wells Fargo analyst, says that the recession ended in June. Michael Murphy of New World Investor also says the recession is over. Maybe I’ll write more about that later.)

According to Thornberg, the following sectors of the economy are leading us to recovery:

• professional services
• export services

In addition, Thornberg states that, although the manufacturing sector is not growing, this sector  is “firming up.”

Before I go on to state what Thornberg sees as the sectors that will be the lagging indicators in this recovery, here is what Joel Kotkin, a fellow with the New America Foundation, says about the professional services sector:

Media coverage of America’s best jobs usually focuses on blue-collar sectors, like manufacturing, or elite ones, such as finance or technology. But if you’re seeking high-wage employment, your best bet lies in the massive “business and professional services” sector.

This unsung division of the economy is basically a mirror of any and all productive industry. It includes everything from human resources and administration to technical and scientific positions, as well as accounting, legal and architectural posts.–Joel Kotkin, “Best and Worst Cities for High Paying Jobs,” Forbes

Unfortunately for those of us who live in southern California, Forbes ranks Los Angeles-Long Beach-Glendale as the fourth worst area to find these jobs and the Irvine-Santa Ana-Anaheim area as the seventh worst.

Now for the lagging economic indicators: According to Thornberg, improvement in the following sectors of the economy will not show considerable improvement until sometime after the recovery has begun:

• construction
• finance
• retail

Thornberg, as well as most other economists, sees employment (which is a factor of all of the above mentioned economic sectors) as another lagging indicator. He also states that recovery in each sector will vary from region to region.

Note: For Beacon’s economic forecast, see Beaconomics.

GRAPH COURTESY BEACON ECONOMICS

Note to homebuilders: Small homes sell! Why? Because they are affordable.

Now that we don’t have a housing bubble that will inflate prices, home prices will need to return to something that approaches income parity. During the bubble years, when many homeowners bought more home than their income justified, the income-to-home-price matchup was something that disappeared. Instead homeowners relied on continuous refinancing, made possible by constantly increasing home values, to keep payments at a level they could manage.

Since smaller homes were not as profitable as large homes, homebuilders were eager to oblige the homebuyers by building ever-larger homes. This was particularly true in Orange County. The post-boom result is that Orange County is short on small, and therefore more affordable, homes.

As we know now, home prices are no longer increasing; they are decreasing.  The home building business model of the past can not be sustained. As economist Chris Thornberg, a principal at Beacon Economics, has said, the housing market will not recover until home prices match incomes. (For a look at what that means in Orange County and how much more O.C. home prices will need to drop, see one of Jon Lansner’s posts.)

An Associated Press article backs up this smaller-home theory.

“KB Homes slashed its first-quarter losses by 75% as first-time homebuyers flocked to the builders’ smaller and more affordable homes…”

The article went on to say:

“First-time buyers accounted for 70% of its first quarter sales, up from 53% in the first quarter of 2008, and they represent ‘the most attractive segment of the market, as they do not have to sell a home before purchasing,’ said Jeff Mezger, chief executive.”

Other homebuilders might benefit by following this example from KB Homes. Potential homebuyers might also benefit from a housing market that has homes that they can actually afford. And Orange County businesses might benefit if the available housing stock can accommodate workers at all levels of the job ladder. This is something that Orange County businesses have been championing for some years.