Outlook 2007: Reverberations Of The Real Estate Slowdown

By Luigi Frascati

About a year ago I wrote an article entitled “Breaking The Real Estate Bubble Myth”, which won great acclamation among readers – at least judging by the many positive e-mails the article generated. It also catapulted me, so to speak, in the spotlight of the local news when a television station requested an interview, which I happily granted.

In the article I pointed out, among other things, that for 2006 real estate markets were expected to settle to new, more commensurate pricing levels and that, furthermore, a cooling-off trend through higher interest rates would have the beneficial effect of consolidating market wealth achieved thus far. The real estate bubble would be likely to burst if no pressure were applied on speculation, thus increasing prices even further and causing demand to lower and finally collapse.

Instead, allowing the economy to get an even footing through a slowdown of capital appreciation and at the same time allowing real wages to catch up, I reasoned, would be exactly the tonic needed for a healthy foundation. Higher interest rates, moreover, promote domestic saving and attract foreign capitals thus reinforcing both the Greenback and the Loonie, another beneficial factor in finance albeit not in trade.

Approximately twelve months down the road this forecast seems to have come true, for the most part.

In general lines spending fuels consumption, which in turn erodes a limited quantity of resources. This is the concept behind inflation in an economy founded on scarcity of goods, which is typical of all capitalistic economies. There is nothing that increases spending more than speculation, defined as the purchase of capital goods, which are instantaneously consumed – i.e. sold for profit, and in North America we all have done a great deal of speculation in the past few years, especially in Real Estate.

At the end of 2006, there is no longer any doubt that the housing slowdown is well under way, both in terms of new construction as well as falling housing prices. In the United States in particular, new numbers released by the National Association of Realtors (NAR) indicate that the median price for existing homes fell by 1.7 percent in the year to September, and that the median price of new construction suffered a drop of 1.3 percent for the same period. And since inventories of unsold homes in many areas are unusually high, NAR forecasts that prices are bound to drop even further, at least through the first quarter of 2007.

In Canada the situation is somewhat better, as reported by the Canadian Real Estate Association (CREA), in that inventories of unsold homes are not as high as in the United States. Still, CREA reports a drop of median prices for single-family detached hovering to about 1 percent as of September, and anticipates a downward pricing trend through the first quarter of 2007 as well.

Today’s debate, however, is less about the scale of the housing slump than its consequences. Will North America be dragged down into a recession or will the economy somehow shake out the property bust? Most Wall Street economists as well as most analysts of major banks in both the United States and Canada put the odds against a recession. And Fed Chairman Ben Bernanke sounds somewhat optimistic as well, although with a great dose of reservations.

The economy is definitely slowing, particularly in the United States, but this is not entirely due to Real Estate. There are political factors as well, the likes of the continued instability in Iraq and an increasing unrest in the Middle East in general, and the shift in power in Congress that play a pivotal role in economic affairs. GDP is now expected to increase at an annualized trend of 2 percent, which is well below trend, in the fourth quarter, and the most direct and least debated effect is the drag on overall output, as builders cut back substantially.

Add in the effects of unemployment: as housing stumbles, economists reckon the industry will shed jobs, pulling down the overall job growth to less that 100,000 per month throughout 2007, thus pushing up the unemployment rate. Whether, therefore, all this will translate into a recession is a matter of debate, and will depend entirely on how consumers will react.

Whereas it is in fact true that consumers, especially Americans, are going to feel less wealthy and will not be able to use their homes as gigantic cash-machines by financing their spending habits through the use of their equity, it is indeed a matter of fact that the link between mortgage-equity withdrawal and consumption is no longer as important as anticipated. The pace of equity withdrawal has already slowed without particularly dire consequences, falling from a high of 7.9 percent of disposable personal income in the third quarter of 2005 to 3.3 percent in the third quarter of 2006 (Source: US Department Of Commerce).

Because the mortgage-equity link is weaker than expected, arguably falling house prices will have a milder effect on consumer spending, thus reinvigorating consumers confidence. For the final result to be tallied, we will have to wait for the US Department Of Labour to publish its 2006 tables in early 2007.

More important for the overall state of the economy, furthermore, is the fact that the chilling effects of weak house prices are being countered already by other boosts to consumers, particularly from lower fuel prices and stronger than anticipated income growth. The Department Of Labour reports that wages and salaries have grown at an annualized rate of 7 percent to September, and that oil prices have fallen an average of 45 cents per gallon in October. Both indications these, that would suggest that consumer confidence is on the rise and should continue to remain high in the forthcoming months. And if that turns out indeed to be the case, the economic reverberations of the slowdown in Real Estate will be definitely toned down.

Luigi Frascati

Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia. He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real Estate Chronicle where you can find the full collection of his articles on Real Estate Economics and Finance. Luigi is associated with the Sutton Group, the largest real estate organization in Canada, and is based with Sutton-Centre Realty in Burnaby, BC.

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