I hear buzz words and phrases like “recovery” and “return to normal” as well as “finally picking up” in the news a lot recently as it relates to the Phoenix housing market.

Everyone loves good news about housing. There is no doubt that real estate prices in Phoenix have come a long way since the 2011 trough of the U.S. housing crisis. Even if you don’t own real estate, rising real estate prices are generally a positive indicator of modest inflation and rising wages locally in Arizona and across the larger national economy.

So what is the problem?

The troubling part about this recovery narrative is that it has been 10 years since the onset of the housing crisis in the summer of 2006. That was over 121 months ago. If we are just now getting back to normal levels of price and consumption, the headwinds must be strong.

And, in my opinion, several problems still exist. The veneer of the residential real estate market is beginning to crack. Here are my primary concerns for the near term future:

The market needs millennials to jump in.

Millennials (born 1982-2004) are today’s “starter” home buyers who help earlier homeowners move up the ladder. This generation at 75.4 million is massive. In fact, it just overtook the Baby Boomer generation in size as the largest living generation in the United States.

For the fourth year in a row, Millennials now make up the largest group of home buyers (35% of the total) in the United States. That is an economic force to be reckoned with.

However, Millennials are not buying homes as they enter the workforce like previous generations. They are more mobile and are getting married later which delays household formation. The fertility rate across this new power generation is alarmingly low (500K fewer babies annually compared to ten years ago). But these are lifestyle choices that could turn around in the future. It is the external forces on Millennials concern me the most.

The unspoken reasons

In my mind, there are three principle forces acting on Millennials and preventing them from embracing homeownship in 2016:

  1. Student loan debt is crushing Millennials. According to Keller Williams co-founder Gary Keller, 75% of recent college graduates carry education loan balances. The average indebted graduate is responsible for $373/month in student loan payments. Almost 40% percent of student loans are delinquent.
  2. Millennials witnessed family members lose homes to foreclosure and short sale in the financial crisis. They were the silent collateral damage. As a result, they no longer see a home as an asset, but as a liability. Even rising rents are tolerable if they afford an easy out in an uncertain economy.
  3.  They have temporary jobs out of school, but Millennials haven’t cemented their careers yet. They wait for the careers that will align with the post secondary degrees that they are now paying dearly for.

When newer income-enabled generations like the Millennials are not buying, other homeowners are not moving up the ladder in to larger homes with better amenities. The absence of buying in the starter home price ranges stalls consumption on higher rungs.

And Millennials with large amounts of student debt who do own homes can’t move up easily or they may simply decide to stay put.

“Psst. Wanna cheap rate?”

Low mortgage interest rates are everywhere. In fact, there are never-before-in-history low mortgage interest rates all around us. Sure, these rates help affordability and buoy home prices. Home buyers should be tripping all over themselves to lock these rates in. But they aren’t.

Homeowners may be refinancing en masse, but low rates are not fueling a home buying frenzy.

Remember a few years ago when a 5.5% 30-year fixed rate on your mortgage was a steal? If you have a 5.5% 30-year fixed rate today and haven’t refinanced to the mid 3% range, you look out of place.

Buyers aren’t impressed anymore with today’s 30-year fixed mortgage interest rates at 3.41% . How low will rates need to go to convince buyers to re-enter the market and lock in low rates? Unfortunately, I don’t think that buyers could move the needle much further even with 30 year fixed interest rates in the 2% range.

It reminds me of the economics principle of diminishing marginal utility. The 15th ice cream cone today is not as desirable as the first, regardless of a lower price. The same is true with rates. Refinancing repeatedly as rates fall over a few short years can get expensive, especially if your break-even horizon is several years in to the future.

Can we keep these low mortgage rates around?

The Federal Reserve does not directly set mortgage interest rates, but it does control levers that can influence the mortgage rate market.

We can’t have low rates forever because it isn’t healthy. Eventually, the Federal Reserve will have to raise rates. It will happen voluntarily or involuntarily. The voluntary scenario means that the Fed sees a rocketing stuctural recovery not witnessed since the 1960s. The involuntary scenario means international bond buyers demand higher rates when the dollar weakens amid more money printing, stimulus and “helicopter” money. I don’t see the former scenario winning out.

[bctt tweet=”When rates go up in the future, and they will…what happens to home values? If demand stays roughly the same, home values go down.” username=”arizonareport”]

Central bank tinkering in the economy will have consequences. Even the chief economist of Deutsche Bank came forward recently saying that monetary policy from the world’s central banks is not working and is doing harm. Market forces will eventually prevail.

When rates go up in the future, and they will…what happens to home values? If demand stays roughly the same, home values go down. Rising rates mean falling home prices because buyers have higher payments. With a higher monthly payment, you can’t afford as much house.

Sustained falling home prices would eventually cause the foreclosure rate to rise. It feels to me like we have painted ourselves into a corner with these artificially low mortgage rates.

and those jobs…

We are living through the most sluggish (read:worst) jobs recovery in the post-WW2 era. Eight years is a long time. Employment and wage growth slowed to a crawl in May of this year. The Bureau of Labor Statistics (data gathering arm of the Department of Labor) reported that a dismal 38,000 jobs were created. However, those were mostly in government and health care sectors. The private sector jobs are hurting and those are most critical to an overall healthy economy.

But wait, the national unemployment number is at 4.7%, right? The Department of Labor unemployment statistic no longer account for those:

  • who want to work, but have abandoned their search in the last 4 weeks
  • working part-time, but who desire full-time work (underemployed)
  • who perform only a few hours per week of work for any amount of pay
  • retired and seeking employment
  • who have gone back to school to improve their job prospects and are not working

Americans can sense that the job environment is not healthy. According to this CNN article, mid-life Americans without college degrees are the “new unemployables.” The media rhetoric of the nation being near “full employment” just does not sync with those over 45 who, according to the Department of Labor statistics, spend an average of 9 months securing new employment.

In 2015, the CEO of American public polling firm Gallup, Jim Clifton, made the claim that federal unemployment numbers were “The Big Lie.” According to his research, over 30 million Americans were unemployed or severely underemployed and not accurately represented in the Labor Department’s statistics.

And at the end of the day, people need jobs to feel confident about buying a home.

It’s quiet at the top.

Around greater Phoenix, the formerly brisk pace of purchase activity in price ranges over $1 million has dwindled to a crawl. It may be uncertainty surrounding the U.S. presidential elections in November or the whipsaw volatility of the Dow Jones Industrial Average over the last calendar year that gives pause to wealthy home buyers in the luxury market. The immediate cause of the drop in activity is not clear, but the effect is.

According to The Cromford Report™ author Michael Orr, luxury home purchases in the Phoenix MSA over $1.5 million have fallen 44% in 2016 compared to one year earlier.

Is there any good news?

Where is the silver lining for Phoenix housing? On a positive note, Maricopa County is the largest destination for second home and vacation home buyers in the United States. The climate and lifestyle here will continue to draw Baby Boomers to places like Phoenix, Scottsdale and Mesa for decades into the future. This is especially true for those Boomers near retirement who delayed a primary or vacation home purchase during the housing crisis.

And since the US dollar is considered one of the last safe havens in times of financial trouble, overseas buyers are picking up real estate here. According to a 2016 study by the National Association of Realtors® (NAR), foreign buyers spent $102.6 billion on 214,885 U.S. residential real estate properties in the 12 months ending in March 2016.

[bctt tweet=”Arizona was among the top 5 U.S. states to draw foreign residential investment. The other states included California, Florida, Texas and New York.” username=”arizonareport”]

In just the last 30 days, the Brexit vote, terror attacks in Nice and the further prospect of negative interest rates abroad on government debt is moving money into tangible assets like U.S. real estate.

Canadians love the Valley of the Sun

Arizona has a special appeal with our northern neighbors. Canadians have had a strong presence in the Phoenix metro area since the beginning of the housing crisis in 2008. There are currently about 22,000 Canadian-owned homes in the Valley of the Sun. In addition, European and Chinese buyers are beginning to buy residential real estate as a vehicle for asset protection (though these two groups make up a much smaller portion of foreign home buyers in Phoenix than Canadians).

Long term optimism

I am optimistic long term on the Phoenix real estate market, but I think that the clouds on the horizon will be here for the near term. Sit tight if you are waiting to make an elective move for a second home or a vacation home. If your move is mandatory or job related, be conservative in your purchase. Stand by with cash in order to pounce when prices inevitably fall as rates rise.

The question of the pendulum swinging back is when, not if.


Those who cannot remember the past are condemned to repeat it. – George Santayana, (born Jorge Agustín Nicolás Ruiz de Santayana y Borrás) Spanish philosopher, essayist, poet and author.