Housing Cycle Outlook for 2003

The housing cycle affects all of us. Builders, product manufacturers and service providers all estimate home sales volume and home price appreciation when preparing business plans each year. I have analyzed current market conditions all over the country to help you form your own conclusions about the housing cycle as it relates to your business in 2003.

Your ability to adjust your company's strategy based on housing cycle conditions depends on your type of business, the size of your company, your sources of capital and your risk profile.

Large builders: These builders want to allocate as much money as possible to markets and projects with strong appreciation potential and limited risk. Their companies are geographically diversified, so they have the luxury of analyzing multiple markets and allocating money accordingly.

Small builders: Most small builders generally prefer a steadily appreciating housing market with predictable revenues and expenses. They thrive in lower-priced, supply-plentiful housing markets that are not subject to wild swings in values. Other executives enjoy the thrill of the housing cycle, earning millions during good times and then, hopefully, taking a well-deserved sabbatical during tough times.

The Outlook for 2003
I believe the three primary determinants of the status of the housing cycle are affordability, demand and supply. My company has developed measures to allow you to compare conditions in multiple markets.

Affordability: The Housing Cycle Barometer compares the current cost of housing (down payment plus mortgage payments) to income levels in an area over the last 22 years. Excellent affordability means the market is affordable compared with its history.

Demand: We measured the job-growth rate and population changes.

Supply: We measured single-family permit levels as a percentage of prior peak permit level since 1980. Low supply levels are good for the appreciation outlook but bad for product manufacturers.

By graphing trends for all three variables over the last 22 years, we compared historical conditions with current conditions and assessed the risk/reward trade-off in 2003. We compiled these graphs for markets around the country and posted them here. Because statistics don't tell the entire story, we also relied on input from local housing market experts.

Selected Markets This appears to be shaping up as a great year for many smaller, more affordable markets. Areas such as Albuquerque, N.M., Nashville, Tenn., San Antonio and Milwaukee have growing employment bases and have had limited price appreciation during the past few years. Many of these areas are benefiting from an influx of buyers from larger, more expensive markets.

We are most optimistic about Riverside-San Bernardino, Calif., where affordability remains better than average, job growth is the strongest in the country, spillover demand from expensive neighboring areas is strong, and supply is 30% below 1988 levels, but rising.

Because many major markets have experienced rapid price appreciation and are losing jobs, our outlook for many of them is not as bullish. We are most cautious on four very expensive markets: San Jose, Calif., San Francisco, Boston and New York. These supply-constrained markets have had rapid home price appreciation during the past few years. They have a history of being highly cyclical because builders cannot meet the demand for housing during strong economic times, which results in consumers' bidding up home prices to unsustainable levels. When the economy slows, prices eventually return to sustainable levels. Wise builders in these markets are building desirable projects with no competition in the new home or resale home market.

Following is our outlook for some of the major markets.

Southern California: With permit activity running at about 60% of 1988 levels, the market is becoming supply-constrained for the first time. The Inland Empire and San Diego are the two strongest job-growth markets in the country. Los Angeles and Orange County deserve more caution.

Northern California: Emerging as a substantial metropolitan area, Sacramento has the land availability, housing affordability, location and infrastructure to become one of the most important metro areas in the nation. High supply levels and job losses could make for a slow 2003, but Sacramento is still a great market for the long term. Because of a 3%-plus-per-year rate of job losses and poor affordability in San Francisco and San Jose, we would limit investments in northern California despite the low supply.

North Florida: Jacksonville, Orlando and Tampa are poised to be major growth areas for the next decade. South Florida: Miami, Fort Lauderdale and West Palm Beach have experienced rapidly rising prices because of increasingly limited land supplies. These markets might be joining the ranks of the highly cyclical, supply-constrained markets. They are expensive by historical standards, but current prices might represent the new standard.

Texas: Supply is near record levels in almost all markets because builders have been able to build homes to meet supply. Because of the high supply, prices have remained relatively affordable, which limits the risk of investing in Dallas, San Antonio and Houston.

Atlanta: Homes are affordable, but demand is low and supply high. Builders need the 2.6% annual rate of job losses to improve for conditions to improve in 2003.

Las Vegas: Place your bet in Las Vegas. Declining permit activity supports builder claims of low supply. Job growth is strong, and homeownership demographics are phenomenal because of the number of young adults who have settled there in the last decade.

Phoenix: "America's back office" continues to build record levels of housing. Once America's economy improves, so will Phoenix's. Prices are fair by historical standards, but demand is low and supply high.

Denver: A high rate of job losses, relatively high supply and moderate affordability are reasons for a cautious outlook in 2003.

Chicago: At current prices, Chicago poses few risks. Job losses began early in the cycle, so home appreciation was low compared with that of most markets. The appreciation potential, however, is limited because home construction is near an all-time high.