Real estate markets in 2004.

While national business cycle experts insist that the economy is two years into its recovery from a short recession in 2001, real estate markets give the most extremely mixed signals. Single-family residential markets are as strong as can be expected after two years of business cycle growth. Many of these markets finished 2003 with record high levels of activity. However, only a few commercial and industrial markets have advanced much beyond the trough of a real estate cycle. Most real estate investment markets are best characterized as finally showing decreases in vacancy rates, but not justifying new construction. Reasonable anticipations for 2004 Memphis and national conditions are that the markets will have to wait until late in the year to reward investors with rent growth that matches inflation. No new construction wilt be justified, in general, until late in the year.

Glenn R. Mueller, professor at Johns Hopkins University and a research executive with Legg Mason Wood Walker, Inc., rates income-generating real estate markets of all varieties with respect to market cycle conditions in the companys Real Estate Market Cycle Monitor. He rates the national markets for suburban office space, downtown office space, multi-family residential space, and warehouse real estate as still in the first stage of recovery from recession. Second tier regional malls are still to move into the first stages of recovery. Hotel markets are one business cycle step ahead, at Mueller's second step of six stages to reach the middle of a typical recovery cycle. At the fourth stage are senior housing markets and retail factory outlets. These market conditions involve decreasing vacancy rates, but no new construction. Market rents either decrease in these market conditions or increase slower than the rate of inflation.

Mueller's market cycle data indicate that power shopping center real estate markets, first tier regional malls, and health facilities have reached better market cycle conditions. They can expect declining vacancy, rapid increases in rents, and new construction. Mueller's Memphis data indicate that local conditions match those of most other cities in markets for industrial, multi-family residential, retail, and hotel markets.

The tentative markets for income-generating real estate stand in stark contrast to the single-family residential markets. The volume of home sales through the Multiple Listing Service of the Memphis Area Association of Realtors in 2003 exceeded the previous record by 9.2 percent. The Office of Federal Housing Enterprise Oversight reported that prices for existing homes in its data set grew 5.61 percent from the third quarter of 2002 to the same period in 2003. Of the 220 cities in its survey, only four showed price decreases in the latest quarter available.

The figure shows the annualized growth rates of the OFHEO price index for Memphis and for the nation as a whole. Statistical tests indicate that the national growth rate arid the Memphis growth rate are correlated, but past values of the national data do not contribute to a forecast for the Memphis market. Many analysts believe that Memphis reacts slowly to changes in national economic conditions. However, this data set gives no support to that generality when applied to the housing market.

The figure also makes it clear that Memphis area house prices have grown more slowly than the national norm since 1999. The price index for Memphis in the third quarter of 2003 was 2.2 percent higher than in the same quarter of 2002. This was growth, but not growth to match that for the rest of the nation.

Forecasts also appear in the shaded area of the figure. Adding the forecast for the fourth quarter to existing growth data for 2003 gives an anticipated national growth rate of 6.14 percent, in comparison to 3.11 percent for Memphis. For 2004, the forecasted growth rates give an average of 5.20 percent nationally, again exceeding the 3.28 percent price gains in the Memphis area.

Growth in single-family housing prices is important to homeowners, lenders, businesses that Serve homeowners, and political leaders. As a hypothetical example, consider a homeowner who bought a Memphis-area house for $100,000 in the first quarter of 1993. Assume that the house was financed with a $90,000 mortgage and $10,000 in the homeowner's equity investment. By the third quarter of 2003; that house--if average--would be worth $146,491, according to the Memphis price index for existing homes. Even if the homeowner still owed $90,000 on a mortgage, the homeowner's net worth represented by the house would have grown from $10,000 to $56,491. New tax regulations make these gains tax free, except in special cases. The forecast here indicates that the existing house will be worth $153,494 by the end of 2004.

The rate of return on equity investment in single-family residences has been very attractive. The debt investor is also better off. The lender holding the mortgage has much improved collateral backing its debt investment. The great improvement in net worth makes the homeowner more likely to spend on goods and services, benefiting businesses. Finally, since Memphis-area governments are heavily dependent on the property tax, the growth in the tax base may make it easier to finance growth in government, or at least help government adjust to inflation more easily.

Thus, many Memphians have reason to be jealous of market performance elsewhere. That $100,000 house would have been worth $165,560 if prices in Memphis had matched national growth norms.

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Richard Evans, Ph.D. Director of Forecasting Sparks Bureau of Business and Economic Research Fogelman College of Business and Economics The University of Memphis