A Tale of Two (types of ) Cities

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by David Lereah, Chief Economist

 Well, the boom is over and most of our nation's hot housing markets are cooling. Home sales are off 5 to 20 percent in some markets that were once setting annual sales records. But there have been no signs of bubbles bursting as of yet. Real estate activity began slowing about six months ago, and - perhaps with some fingers and toes crossed - our nation's housing industry is managing a soft landing. And quite nicely, thank you. It is true, some of those "hot hot hot" markets are experiencing more of a cooling down than are others, but there is also a silver lining to that: some of America's non-boom markets are showing signs of life.

During the real estate boom's five-year run (2001 to 2005), about 65 of the 135 metropolitan areas on which the National Association of REALTORS� tracks price data experienced robust price appreciation. The households living in - and investors investing in - those 65 boom markets during those five years enjoyed substantial equity gains on their properties and no doubt engendered the envy of non-boom homeowners and investors. Indeed, to the dismay of the remaining 70 metro areas, the boom seemed to discriminate as it passed over them. But today, the housing coin has flipped - sales are softening in (former) boom cities and gaining momentum in non-boom cities. It appears the haves and the have-nots have reversed places.

What is driving that reversal of fortune? The answer is: affordability. Quite simply, affordable metros are in favor and unaffordable metros are experiencing a correction. Let's look at both situations.


Afordable Metros
The recent real estate boom seemed to have bypassed Denver, Salt Lake City, Houston, and Albuquerque, New Mexico; now those markets are raising some eyebrows. In recent months, they have shown a pick up in sales activity. What all four of these metros have in common is a healthy local economy (evident in their job creation figures) and affordable housing prices. It is becoming increasingly clear that in the aftermath of the boom, households are now seeking affordable property to purchase (and live in). For example, there are cases where households living in pricey northern California neighborhoods (such as San Francisco) are moving from an area where the median home price is a lofty $730,000 to areas with substantially lower median home prices. Denver and Salt Lake City - as well as some still-hot markets like Las Vegas and Phoenix - could be the fortunate recipients of that trend.

Another way of viewing a healthy housing market is to look at the direction of months' supply of homes available for sale (the housing inventory). The top ten metros ranked by the largest year- over-year decrease in months' supply in February, reveals that nine out of those ten areas are affordable markets. Led by Austin, Texas, which experienced the largest decrease (falling from a 5.0-months' supply in February 2005 to 4.3-months' supply in February 2006), the remaining nine metros were Houston, San Antonio, Raleigh-Cary, Albuquerque, Mobile, Fort Myers-Cape Coral, Kansas City, Beaumont-Port Arthur, Texas and Baton Rouge. Only Fort Myers-Cape Coral, Florida experienced the real estate boom and has a median home price higher than the national median home price.

Again, all of these metros share the two characteristics that are attracting future home buyers - a healthy local economy and a relatively low median home price. I expect these metros as well as other affordable and healthy metros to exhibit slow- to moderate growth during the remaining months of this year.

Boom Metros
Phoenix, Naples, Florida, and Washington, DC all experienced the boom during the past five years, but are now showing strong signs of cooling. What they all have in common are a history of robust price appreciation and a healthy local economy. Ranking the top ten metros by the largest increase in months' supply (which is a sign of a "cooling" market) in February reveals that all ten metros were boom metros. From first to tenth are Phoenix, Palm Bay-Melbourne, Florida, Pensacola, Florida, Chicago-Naperville, Hagerstown-Martinsburg, Tucson, Orlando, Boston, Washington DC, and Worcester, Massachusetts. Phoenix experienced the greatest increase, where its months' supply rose from 1.2 months in February 2005 to 5.6 months in February 2006. Sales in all of these metros have also fallen within the past 6 months.


A Happy Ending
The good news is that affordable metros are beginning to expand while boom metros are cooling into a soft landing. There have been no bubbles bursting, as predicted by so many academics and Wall Street analysts during the past several years. The last time a bubble burst was in Boston in 1990/91.What happened in Boston? It experienced a negative local economic event - a sharp recession. During that time, Boston lost 15 percent of its labor force and the months' supply of homes climbed up to a remarkable 16 months! Something had to give so prices tumbled downward for the next four years. The difference between Boston's experience and today's cooling metros is the health of the local economy. Boston's economy experienced a contraction, while our boom markets all possess healthy, expanding economies. With job creation and income growth, households will continue to have the wherewithal to purchase property even in cooling local markets. That is a perfect recipe for a soft landing.