How Arizona’s financial woes will affect your home’s value

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Viewpoint 02/03/2010

How Arizona’s financial woes will affect your home’s value

“A stick-figure explanation of a complicated question.”

Arizona’s recent budget deficit has been in the news almost daily over the last month.

Brewers Budget Plan seeks to tax agencies & increase sales tax (azcentral.com)

City of Phoenix details plan for drastic cutbacks (azcentral.com)

Phoenix managements’ 6-figure salaries a concern (azcentral.com)

Struggling cities eye taxes for budget shortfalls (azcentral.com)

Arizona tax hikes and so-called balance budget proposals (economist Michael Shedlock)

Massive Layoffs coming in NYC, Nevada, California, Colorado, Arizona, Everywhere (economist Michael Shedlock)

This raises some big questions, such as:

• What will this do to our recovery?
• Is this a short-term or a long-term problem?
• How are they going to fix it?
• And most importantly, how does this affect *me*?

In this letter I’m going to explore some possible outcomes of the current economic climate. Please note this is a topic with more potential to spill into a discussion on politics than anything I’ve ever written about before; I’m not a political writer and will do my best to keep politics out of this letter.

Communities are just really big families

First of all, let’s start by taking a look at a more simplified example – an average family. Cities, Counties, States, Federal Governments, and Corporations aren’t any different fiscally from a family, except the numbers are much larger, more complicated, and have longer time horizons; the concepts are exactly the same.

Families get into financial trouble for many reasons – loss of job (reduction in revenue), unexpected increase in expenses, spending more than they make until eventually they run out of credit lines, or any combination of the above.

Many families who lose a job (or take a reduction in pay), feel ok using credit to bridge the gap until they find a new job. This can work out well if they find a new job quickly, but can lead to disaster if they don’t. Eventually the money they’ve borrowed becomes an additional required monthly payment, which pushes them in the wrong direction.

Many families fail to make drastic changes to their habits until it’s too late and the tragic end is in sight.

Cities, States, and Countries are acting in very much the same manner; the only question is whether they’ll find a new job quickly enough (or when will tax revenues return to expected levels?)

Arizona is not alone

This would be a much different problem if Arizona was the only state in financial trouble, but it’s not. Here are some recent articles about other states’ and cities’ woes:

Massive Layoffs coming … everywhere

Miami faces financial meltdown

Wisconsin’s Pension Strategy

Oregon’s death spiral

Cash-Strapped Illinois accelerates property tax collection

Kansas budget deep in the hole

Escalating pension crises will bankrupt San Diego

And we all know the Unites States of America is headed down a similar path – massive budget deficits fueled by bloated spending, bailout promises, and a reduction in tax revenues.

Even the US is not alone

Leading economists have been writing for months that the crises we’re currently in is global.

Crises in Spain & Greece

No way out for Japan

If PIIGS could fly. John Mauldin’s 2/2/10 Outside the Box newsletter discusses the problems in Europe, especially Portugal, Ireland, Italy, Greece and Spain. Sign up for this free newsletter at www.frontlinethoughts.com

Level Playing Field

I point out the pervasiveness of the problem only to show Arizona is not at a competitive disadvantage compared with the rest of the country. My outlook would be very bearish if we had massive tax increases ahead while other parts of the country were financially sound. Instead, with many areas in the same boat, people will not be moving to other states to run away from Arizona’s problems, nor will they avoid moving to Arizona specifically because of our problems.

Hello, you.

Now, let’s go ahead and see what our current economic picture looks like: (** author’s note – I don’t claim to be an artist, and you’re welcome to laugh at my expense.)

This is you:

This is all of us in Phoenix together:

We normally run at a 5% unemployment rate (red people), which means not all of us are able to buy houses at any given time.

Currently we’re running at about 10% unemployment, which means 5% more than normal are unemployed (orange people) and unable to buy a home currently.

Most forecasts I’ve read expect the national unemployment rate to level off at about 12% later this year, which means even more people are going to lose their job (purple people) and be unable to buy homes.

And of course, Arizona and the local cities are in the process of laying off public employees (blue people).

The end result is we’re left with a much smaller buyer pool than we normally have, which forces demand down.

And now for supply

This is your home.

These are all the homes in Phoenix.

At any given time, some of the homes in Phoenix are for sale.

Unfortunately, we all know more about the banks these days than we’ve ever known before, or ever wanted to know.

The banks are still buried in the tsunami of foreclosures, and are putting thousands of homes up for sale each month.

These bank-owned homes (red) crowd the normal market, adding extra supply. Prices are pushed down not only because of extra supply (simple economics), but because the banks’ homes are usually not in the best condition and sell at discounted prices to reflect this. In addition, the banks ask buyers to buy “as-is” and without any disclosures; additional pricing discounts are given to offset this.

And let’s not forget about the new-home builders.

Many of them went out of business in recent years. But those that remain are still building homes. 8,027 new-home permits were issued in 2009, and estimates are for 8,500 new home permits to be issued this year. (#s courtesy of azcentral.com)

These new homes don’t do any good to the builders unless they’re sold, so the new homes are added to the market as well (in pink).

Adding it up

So we have far fewer buyers than normal, and we have far more houses available for sale than normal. This has already pushed prices down to levels most of us couldn’t imagine a couple of years ago. Fortunately interest rates have also cooperated, hovering near their lowest levels since WWII. Low prices and low interest rates have helped first-time buyers afford to buy, and investors have stepped up to take advantage of a unique set of circumstances.

Keep in mind we’ve been discussing Arizona, pictured here.

But as we discussed earlier, there are many other regions of the country facing similar political and financial problems.

Historically Arizona’s growth comes from people moving here from other states, to the tune of about 100,000 net new people per year (meaning 100k more move here than move away each year.) I don’t see any reason why this will stop.

• Arizona’s financial woes are probably similar to their existing state/city.
• Arizona’s schools are facing budget cuts. Well, our schools have generally ranked fairly low in most national polls for a long time, which hasn’t slowed down the migration before.
• Phoenix still offers great weather, no natural disasters, inexpensive living, and plenty of parking.

Bottom Line – what does this mean for Arizona Homeowners?

We’re facing some headwinds over the next year or two, but we have some positive information to hang our hats on for the long term. Here are some of the things I’m keeping my eyes on:

Budget Woes & New Taxes.

Any new taxes which are aimed at Arizona & Phoenix residents will have the effect of reducing the amount of money people have available for housing expenses. Any new property taxes will make housing more expensive for local & non-resident property owners. Since first-time buyers and investors are the primary buyers right now, this has the potential to make housing unaffordable or unattractive for this pool of buyers, which would virtually stop our current sales activity.

Interest Rates.

Here is a chart (click to enlarge) showing the historical mortgage interest rates. (image courtesy of www.mortgage-x.com)

I want to focus on 7% interest rates. Notice we were above 7% for 25 straight years – passing 7% on the way up in 1968. We touched 7% briefly in 1993, bounced back up and touched it again in 1999, then bounced up again. We eventually passed 7% again in 2001 and have been below 7% since then.

In other words, we would have considered 7% a very good rate over most of the last 40 years. What would happen if we saw 7% again in the next year or two?

A $150,000 mortgage at today’s 5% rate, financed over 30 years, has a principal & interest payment of $805.23. At 7% interest rate, that same $805.23 will only cover a mortgage of $121,033. This could put downward pressure on demand if first-time buyers and investors can’t balance payments with home prices.

Foreclosure tidal wave passing

It’s difficult to see it today, with the bad news everywhere we look, but at some point in time the foreclosure wave is going to stop. At some point, everybody who faces hardship due to our current environment, who is unable to keep his house, will have lost his house. There will always be foreclosures, but there will no longer be thousands per month. I wrote last fall that I expect the foreclosure waves to subside during the 2nd half of 2011; that still sounds about right.

When the foreclosure waves subside, it’ll happen quickly. It won’t cure all our problems (employment, budget, etc.), but it will have an immediate and drastic effect on our housing market.

New Home Building Permits

AZCentral.com reports new home builders are expecting to issue 22,000 permits in 2012, and they are expecting to be at 2002-2003 levels by 2015. While these predictions may be a little too optimistic, I have to assume the builders will be wary after everything they’ve just gone through.

Final Thoughts

We’re living through the largest financial crises since the Great Depression, and there is uncertainty at every turn.

• There are plenty of reasons to be nervous/cautious over the next couple of years, and things could very easily get worse before they get better.
• Long term, Phoenix (and Arizona) is expected to recover – not necessarily back to 2005 pricing levels anytime soon, but in the sense that people can sell at reasonable prices and in reasonable time frames.
• No sugar coating – the next couple-few years are going to be tough; don’t count on your home gaining in value in the short term. However, long-term, Phoenix still has a rosy outlook; one day we’ll get back to normal with homes appreciating in value slightly each year.

Buying today? If I was buying a home today, I would focus on 3 factors:

1. If you own a home with a fixed-rate mortgage, your home will be paid off in 30 years, regardless of what the market does to rates or prices. Bottom line is you could retire without a housing payment or give your kids a terrific head start on life.

2. Buy a HOME, not an investment. Buy a home you’ll be happy to live in, every day, for the next several years. And once you move in, make it your home – decorate it and use it however makes you the most happy.

3. Pay attention to non-changeable items. Backing to a busy street, size & shape of backyard, # of garage bays, quality of neighborhood – these factors may become more magnified over time, and there’s nothing you can do (short of spending boatloads of money) to change them once you move in.

I hope you enjoyed this e-newsletter, and found some value in it. Please feel free to leave a comment or add additional insight by using the form at the bottom of the online version, found here.

Here’s to surviving the next couple of years – if we can survive we’ll soon prosper. Cheers.

Chris Butterworth

Chris & Heather, The Phoenix Agentsat Thompson’s Realty

http://thephoenixagents.com

623-570-9940

Chris Butterworth and Heather Barr are The Phoenix Agents at Thompson’s Realty. The Phoenix Agents are Realtors in the Greater Phoenix area, who have built a loyal following over the years by offering superior service levels coupled with a low-pressure approach. You can visit http://ThePhoenixAgents.com online to learn more about Chris, Heather, and the Phoenix-area real estate market. If you have real estate questions or needs, please contact us anytime; we’d love to hear from you.

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