Real Estate

It is exciting to see a real free economic market in full correction. The 3rd Quarter Case-Shiller home price index shows arizona as having year over year value declines close to 9%. Month to month declines nationally show an accelerating trend in home price depreciation--this means we are still picking up speed on our way down to the bottom of this market. For all prudent and patient consumers out there this is great news. For the would-be first time home buyer recently priced out of the market, this is good news. Frankly, it is good news for just about everyone and I think we will give back all of the 50% gain we had from '04-'05 and then some.

Personally, I am very interested in what will happen to rental rates in the next 24 months. Recently, apartments have shown some weakness in rent growth (read: no rent growth over teh last quarter) and rising vacancies and concessions (discounts and deals offered to lure renters). Typically, these don't disappear overnight, but here's why I'm not that worried:

Price is a function of supply and demand. In this case we are talking about the rental price or rate (ie. economic rents--a combination of market rents less concessions). When supply is added to a market with constant demand, the rents landlords can charge will decrease. Recently we have seen additional rental housing supply dumped into the market in two forms: broken condo deals and investors renting out houses.

Over the past few years, hundreds or even thousands of apartment units were removed from the rental supply because developers planned to convert them into condos. Many of these projects went belly up halfway through the selling period. So... supply was taken out of the market (when renters were booted in preparation for selling the condo) and then dumped back into the market.

The other market supply contributing factor to flat rents and rising concessions is the increased availability of single family homes for rent. As investors find it increasingly difficult to sell vacant homes, many are resorting to renting the home hoping for a better market 12 months from now. Single family homes and condos are a substitute for traditional apartment living and could be considered an economic substitute--drawing renters out of apartments. Essentially, this factor has increased available rental supply, putting downward pressure on rents and contributing to the weakness in vacancies and concessions (free microwave, 2 months free, etc.)

Where we go from here:

The surge in single family homes for rent and the failed condo conversions reverting back to apartments is commonly referred to as the Shadow Market.

I think the shadow market is about as large as it will be in this cycle. My opinion is that the failed condo deals are already in lease-up and will be fully occupied within the next 3-6 months. I also think it is likely the investors who have decided to 'ride out the storm' have already put their houses in the rental pool.

I also think that most of the home buyers in this marketplace are buying homes to live in, not for investment purposes. So, although we are still at the front end of a foreclosure Tsunami in Phoenix and in the nation, I think these homes will largely be sold to individuals who will truly be able to afford the payments and who plan to live in the homes. Some distressed foreclosures may wind up in the hands of investors but my hunch is that this activity will not have a net increase affect on the available homes for rent in the marketplace.

It will take a few years for the shadow market to return to historically normal levels (whatever that is...) because many investors will be able to supplement their investment home mortgages and will do that instead of going through foreclosure, and here is my point:

THE APARTMENT MARKET IS THE BRIGHT SPOT over the next few years. Specifically, new apartment construction. Historical data shows the Valley is far from being 'over-built' relative to multi-family product. It is also safe to say that the thousands that will loose their homes to foreclosure are going to return to the renter pool--thus increasing demand for rental housing. A dissipation of the shadow market and the return of renters to apartments will play out over the next five or so years WHICH WILL CAUSE HEALTHY RENT GROWTH AND LOW VACANCIES.

This is my opinion and I could be wrong. I am interested in any feedback or opinions in support or in contradiction. Thanks, Mark.