Wednesday, May 24, 2006

Good Cop, Bad Cop

The long boom in the real estate market appears to be over. Higher interest rates and soaring prices have begun to bring some local markets to a halt. In places like Illinois, where prices haven’t risen dramatically, the adjustment will be mild. The real uncertainty is what happens next. Will the economy begin to steam along, or will the combination of international tensions and oil prices cause it to stall as well? Closer to home, what will the next revolution of the real estate world bring for brokers and agents? Read on for answers to these and other penetrating questions.

The good news and bad news about the economy

Economic forecasting is a less than exact science. In fact, it's downright primitive. When you hear a pundit giving you a numerical forecast in grave tones, understand that it is wrong. Not intentionally wrong, but rather as mistake made by someone who thinks he knows more than he actually does. It's better for you to understand the forces that will shape the future of the economy and then apply those forces to your own business and your own market. So, here goes.

Good news

First, and foremost, the demographic structure of the United States is ideal for preserving a steadily growing economy and a strong real estate market. The baby boom, which has caused so much of the economic and social history of the United States over the past half century, is still in place and still productive. The largest single age group of the boomers is 49. This means that the 75 million or so people born between 1946 and 1964 are clustered in a time of life when they are at their career peaks—and when they are moving into the best home they will ever inhabit. Their productivity keeps a high floor under the economy, ensuring that what recessions occur are most likely to be mild and short.

Second, the Federal Reserve has managed the economy in an effective fashion. While former Fed Chairman Mr. Greenspan was not right all the time, he was right about where monetary policy should be far more often than he was wrong. The result has been a low interest rate climate that has fostered economic activity and reduced the cost of homeownership.

Finally, the world is flat. The term used heavily by columnist and author Thomas Friedman capsulizes the integration of the world's economy. The labor force available to American manufacturers is worldwide as is their market. The result is a greater availability of goods at lower prices than has ever before faced the American consumer.

Bad news

With the good, there come some wild cards. Some of this is bad, but much is just a yellow flag that needs to be watched to see if it turns red. First, we have a new Fed chairman. Ben Bernanke comes to the job with the confidence of the financial community, just about the only requirement in the job description. But he's not Alan Greenspan, and we don't know yet whether his models have the same sure touch and feel for what's needed that Mr. Greenspan's street smarts had. This will develop over the next year or so, so keep watching the Fed.

Second, we are borrowing a trillion dollars a year to cover our trade and budget deficits. So far, it hasn't hurt us much as the rest of the world seems to want our debt at pretty reasonable rates. But it leaves us vulnerable to a long-term rate hike, and to being hamstrung in dealing with issues that concern our creditors. We need to get the federal budget under control at the least, even if we can erase the trade deficit.

Finally, our addiction to oil puts us at the mercy of an unsavory bunch of characters. It seems that every country that has significant oil reserves is either untrustworthy (Russia, Saudi Arabia), unstable (Nigeria, Iraq) or is ruled by a tin horn dictator who hates us (Venezuela, Iran). The more we rely on foreign oil (now more than 50 percent of what we use), the more vulnerable we become. It's more than price, although that could have a draining effect on this economy. It's international politics as well.

That said, my opinion is that the good news prevails and this economy proceeds decently (although far below potential) through 2006 and 2007. Growth should be around three percent with inflation edging up. Long-term interest rates will be up about three-quarters of a point by year's end, and the employment picture good, but mixed.

The real estate market

We've had a decade of strong real estate sales. Now rising prices and interest rates will slow down in 2006. Even if the pessimists are right, though, and sales fall by 10 percent, this will still be better than any year of the 20th Century. The question facing the market, however, is whether this is the pause that refreshes or the fall of a skyrocket.

The answer will differ for different markets. The key will be employment. In those markets where the underlying economy is sound and growing with the national economy, the housing market will revive just as soon as prices adjust to the level of income. For others, the real estate market will stagnate and the price corrections will be harsh.

The issue facing agents and brokers is how to transition from an “order taker” market to one where actual work has to be done. With the rapid expansion of the number of REALTORS® over the past five years, most of the industry has little to no experience of anything but a growing market. Brokers need to invest more heavily in the tools and training their agents need to understand how to operate in a down market. Agents have to realize that it's not the end of the world.

By John Tuccillo, Ph.D. (Economist)
Illinois Association of Realtors

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