Real estate has traditionally been viewed as the best example of a cyclical market, as buying activity routinely crescendos, turns suddenly and then falls off, causing prices to drop. Then, the cycle begins again. This cycle is easily correlated to that of the economy: When interest rates are down and employment is up, the real estate market is stronger. It’s not rocket science, but paying attention to the forecast of the cyclical market can benefit you and your clients.
By K.K. Snyder
The cyclical nature of real estate means it is dynamic, says Delores Conway, Ph.D., director of the Casden Forecast at the University of Southern California Lusk Center for Real Estate, which is considered a national expert on real estate market forecasting. The market is currently in a correction phase that began in spring 2006, following huge price increases year after year, which are not sustainable, adds Conway. “We’re moving to more normal levels of appreciation like 3 to 6 percent,” she says.
Builders responded quickly to the correction phase by halting construction and, in some cases, even selling the land on which they were planning to build and delaying new units coming online, says Conway, who teaches analysis of real estate. She predicts the correction period will last one to two years. “Then, we’ll see the price declines stop and a flattening, followed by more normal levels of activity,” she says.
Unlike some areas of the country, Chicago had normal levels of appreciation, “steady as she goes,” says Conway. Though some overbuilding has occurred, especially in terms of infill development, which has almost proven to be more than the market can bear, the Chicagoland market has fared quite well. “Supply got a little ahead of demand, but not to the extent of the old days,” she says. “Instead of ‘boom, bust,’ it’s now ‘boom, plateau.’”
Closer to home, Dick Greenwood, VP, Builder Marketing Division for Coldwell Banker Residential Brokerage, agrees that the employment rate and job growth directly impact the cyclical real estate market. “In Illinois, we are lucky to have positive job growth for the last two years, while our neighbors in Indiana and Michigan have had zero or negative growth,” says Greenwood. “Jobs are plentiful, we just can’t find workers.”
Research from the economists at the National Association of Home Builders states that for every 1.7 new jobs created, the industry gets one housing start. With the unemployment rate at 5 percent, people who want to work will find work, says Greenwood. If an area has a strong population growth and employment growth, it has a strong housing market. “An area’s housing market will prosper or slide as its local job market expands or contracts,” he says.
Illinois’ strong population growth in Chicagoland is also driven by international immigration. Chicago is a strong “entry city” for international immigrants. “As long as we have an excellent college and local education scoring high marks, we will continue to be an attractive point of entry,” says Greenwood. “Chicago, San Francisco, Los Angeles and New York lead the nation in this area. This immigrant buyer will drive the housing market in years to come.”
The local economy also has a strong influence on the real estate market. One must always think of real estate in local terms, rather than national, says Greenwood. “With O’Hare International Airport, Illinois business leaders can get anywhere, either nationally or internationally, quickly,” he says. “But, we must also look at our excellent roadway system,” he adds, noting the huge trucking depots in Elwood that have been a positive influence on housing in both Elwood and Joliet.
“The same holds true for Route 39 and I-88 in Rochelle; look at the homes going up in DeKalb, Sycamore and Aurora. Because the local economy is healthy, and mortgage rates remain at 30-year lows, we have seen that our home prices are still increasing, just more slowly than before,” Greenwood says.
Long-term home prices in Chicagoland have seen some small market adjustments, but never a major decline. Looking back as far as 1975, there have been only six quarters when the price increases were negative or non-existent, says Greenwood. “No market can sustain increases of 20 percent or more every year,” he says. “Wages can’t keep up, therefore demand has to drop. This is what we saw last year. In the Chicgoland market, we were very lucky to see realistic price increases in the past, so we should bounce back faster than many markets.”
“The inventory level is high,” is a common phrase in the industry. In 2004, 2005 and early-2006, home builders were building many homes on speculation. The market has adjusted to a lower level of sales, thus causing the home builder to do one of two things. First, he must cut back on production, which did occur during the last three quarters of 2006.
“In Chicagoland, we saw very few builders building any more specs in 2006,” says Greenwood. “The goal is to get rid of standing inventory. This leads to the second step: lowering prices, thereby reducing the profit margin, or giving incentives to encourage people to buy. We saw all of this happening in the second and third quarters of 2006. During the last quarter, we saw the standing inventory really reduced, so the incentives offered decreased except in the high rise market.”
All economists, builders and real estate agents study the Consumer Confidence Index, Greenwood continues. This index, as its name implies, measures what confidence the consumers have in the economy. Unfortunately, this is a highly subjective measurement, since it measures a “feeling,” not an actual product.
“In recent months, the press has reported nothing but negative stories about such items, the ‘housing bubble’ or mortgage rates jumping up,” Greenwood explains. “This creates a drop in the index. This current drop in the index can be attributed to negative or false press.
“The mortgage rates are excellent, the economy is doing well, employment is full, immigration is up and home prices are increasing…all saying it’s a great time to buy,” he says. “It is time we educate our buyers and fellow agents to the real positive facts. Only two periods in history were better than today in the housing market; the problem is consumer confidence.”
With 20 years of experience in the industry in Chicagoland, Liz Scheffler of Century 21 Sussex & Reilly agrees that the media has played a huge role in consumer perception —or misperception— of the status of the real estate market. “Up until the media decided to tell consumers that the market was going down, the market was doing just fine,” she says.
Scheffler says the Midwest tends to be more stable and realistic about pricing. “We were ahead of last year until the media reports last fall,” she says. “2006 was a banner year.” The problem, she says, is that media reports give blanket statements about the market as a whole, and consumers hear only sound bites of generalized information.
For example, reports last year advised consumers, “If you don’t have to sell your house, don’t,” which Scheffler found ridiculous.
“People tend to believe that November and December are poor months for real estate, but they can be very strong months for sales,” she says. “We had a very strong November and December housing market that was up 3.4 percent.”
The Midwest has enjoyed a healthy market over the past 20 years, once double-digit interest rates became a thing of the past, she says. It’s grown to be more lucrative if you’re an owner or an agent. “This is the first time I’ve seen everyone put on the skids over consumer confidence,” she says. “The economy is up, unemployment rates are down and no one out there is buying or selling.
“Media keeps saying the bubble has burst, but we never had a bubble,” Scheffler concludes. “There hasn’t been, in my mind, a huge 40 or 50 or 60 percent markup in our market. Instead, there’s been a healthy growth year after year.”
Chairman and CIO of Transwestern Multifamily Partners, LLC, Doug Crocker has more than 45 years of experience in the real estate industry and says the last market burst not as a result of interest rates, but as a result of wild speculation and prices spiraling upward.
“Housing is extraordinarily affordable, but people are afraid of it,” he says. “‘Has the bottom been hit yet’ is a huge question. It’s a herd mentality. Ultimately, excess supply causes uncertainty, causes people to slow down and the industry to slow down and prices collapse.”
Crocker predicts a 10 percent to 20 percent pullback in pricing through mid-2007, followed by the beginnings of stabilization later in the year and into early-2008. And overbuilt condo markets in cities like Chicago, New York and Boston will probably see some shake up as well.
“While there will be the cyclicality of real estate in all markets, the violent ups and downs of the ‘60s, ‘70s, ‘80s and ‘90s aren’t going to be reoccurring because of the amount of information out there available to consumers,” Crocker says.
All in all, the industry has a favorable forecast for 2007 and 2008, concludes Conway. “As long as the job market stays strong, real estate will remain steady. But if we have a recession, all bets are off.”
Even if you don’t fancy yourself a fortune teller, you can learn to predict the real estate market and become a valuable source of knowledge for your clients. It’s simple: Keep your eyes on the unemployment and interest rates, follow the trends of your local market and you, too, can predict the cycle of Chicagoland’s real estate market. C.A.
• • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • • •
Contact Information Delores Conway
University of Southern California
Lusk Center for Real Estate
Transwestern Multifamily Partners LLC
Coldwell Banker Residential Brokerage
Century 21 Sussex & Reilly