Metro Phoenix appears to be slowly and steadily emerging from the ashes of the real estate collapse of five years ago, but is the city headed toward a re-bubbling of the market and repetition of all the sordid problems of that historical time?
While some critics believe history is destined to repeat itself, key players in the metropolitan Phoenix real estate industry believe such gloom-and-doom soothsaying is bogus and completely without merit.
‘Growth’ or ‘Bubble’?
Michael Orr, director of the Center for Real Estate Theory and Practice at the W. P. Carey School of Business at Arizona State University, believes the Metro Phoenix real estate market is healing and stabilizing. “The idea that there is another bubble in the real estate market is absurd. We are just seeing a normal reaction to lack of supply. Prices are still below the long-term trend line and none of the conditions that define a bubble are currently in existence.”
While noting that bubbles rarely occur in the same market where they just burst, he observes that “it is fallible human nature to be over-sensitized to them.” But his view is the Phoenix market has not plateaued and will continue to rise until more sellers are tempted to sell.
What we’re seeing is a response to years of constraint, not the beginning of a bubble, according to Mark Stapp, Fred E. Taylor Professor in Real Estate and director of the Master of Real Estate Development program at W. P. Carey. “I think lending and the slow addition of supply will keep this moderated.” Stapp believes that lenders will bear the present state of the economy and people’s ability to pay. Pricing, he says, is driven by tight supply, and once supply is adjusted accordingly, percentage increases should slow down.
Economist Elliott D. Pollack, CEO of Elliott D. Pollack and Company and guest editor of this issue of In Business Magazine, also dismisses the idea of another real estate bubble brewing in Phoenix. If anything, Pollack sees a modest housing recovery. “In 2005, if you could breathe, you could probably qualify for a loan. Today, it’s very difficult to qualify,” he says. He goes on to explain that what was investment in 2005 is now a place to actually reside, and he notes that even those who are investors are renting homes and therefore not adding to the overextended supply pool.
Attorney John T. Lotardo, who covers the industry nationally as “Ask the Titleman” in addition to being senior vice president and general counsel for Stewart Title & Trust of Phoenix, Inc. and state underwriting and claims counsel for Stewart Title Guaranty Company, doesn’t speak of a housing bubble at all. He calls it a housing bounce — and a market correction — that’s definitely moving in the right direction.
There seems to be an increase in employment that enables people to re-enter the housing market, observes Greg Bielli, western regional president of master plan developers Newland Communities and board chairman of Urban Land Institute Arizona. He sees normal growth process returning. “We just don’t have the unbridled development going on because of the last four years. We went from 62,000 permits at the real estate peak to 7,000 permits, for single-family homes,” Bielli says.
Acknowledging that some believe the cost of inventory is too high in certain submarkets, Bielli says scarcity in inventory is nothing to panic about. “It’s just a little bit of a scarcity, because there really isn’t development behind in the pipeline that says there’s more inventory coming online.”
Foreclosures’ Mark on the Market
Helping the comeback is the decline in foreclosures. So what’s behind that decline? Bielli believes the banks worked through all the foreclosures and returned homes to the market. With additional capital in Phoenix, investors purchased the homes and created business models, which included rentals. “Property management companies that are built near the foreclosed homes put renters in those homes. In Phoenix there’s been a definite correction of earlier problems,” Bielli explains.
And capital groups setting up shop in Phoenix is not a bad thing, Bielli says. “These groups bought a lot of inventory that had no buyers at the time, worked through returning capital to the banks, and I think it was a progression that actually helped to stabilize the Phoenix market.” It’s just a matter of time before these investor groups are led back into the market, but, in the meantime, they have a business model of rental homes and multi-family projects that provide housing stock for the community. “We’re gradually coming out, and a lot of us in the industry feel that’s the appropriate way,” Bielli says.
There will always be foreclosures, Stapp observes, but lenders have learned a lot from mistakes of the past. “Simply moving to foreclosure because they can isn’t the best solution, especially in a falling market.” He notes that lenders probably lost more through the foreclosure process than if they had allowed owners to remain in their homes. “Part of the issue is that the mortgages were bundled and sold into very big pools, and investors bought interest in these pools,” Stapp says. When loans fail, resolution is managed by servicers in other states, which creates a marked disconnection from the homeowner and his or her particular situation.
Other options that lenders can avail themselves of, which are less stressful to the market than mass foreclosures, are short sales, legitimate homeowner workouts and loan modifications. Stapp explains that foreclosures often damage neighborhoods whereas with the other choices, homes are not abandoned.
Scarcity of New Homes
According to Michael Orr, real estate hasn’t really changed much in Arizona. “Our biggest problem is not having enough homes for the population that is growing fast again,” he says. Prices have escalated more than 5 percent since January and, unless there is additional supply, prices will continue to elevate over the next few months. But bubbles, he says, form when people have no real use for a traded asset other than profit — which is not the case here. “People actually want to use Phoenix houses for accommodation right now, and we are currently unable to build enough new homes for the incoming population.”
Orr contends that part of the reason building is slow is a shortage of construction contractors, most of which were undocumented immigrants in 2005. As a viable alternative, he suggests a guest worker program for the building trades.
Opportunity for Fraud
Historically, throughout the United States, real estate markets boomed, bubbled and burned due to a variety of factors. Phoenix was no exception to the problems that arose from endless foreclosures, short sales and the fraudulent conveyances that left so many people destitute and homeless. To the suggestion that this situation is continuing, however, Michael Orr is impatiently dismissive. “Foreclosures and short sales are so last year here in Phoenix. They have dropped to low levels that do not have much significant impact on the market.”
Characterizing trustees as “generally a well-behaved bunch,” Orr argues that unethical behavior in 2009-2010 was relegated to bidders at auctions. In the preceding half-decade, most of the unethical behavior was committed by mortgage brokers pushing fraudulent loans, and sellers using straws “to obtain loans for more than their homes [were] worth,” he says.
Stapp notes that, because it’s fairly easy to break into the real estate business and much money can be made, it’s an arena for possible fraud. “The way the process works, collusion among participants is easy, and the underwriting process was not effective in catching this.”
Could it happen again? Possibly, says Lotardo, “but not like it was, because there’s now such a protocol of regulations in place.”
Foreign Investment
Some believe that foreign investors have hurt the Greater Phoenix real estate market by driving up prices of homes. Stapp disagrees. “First, this was not a cash-constrained recession. There was — and still is — a lot of cash looking for good returns,” he says. All types of investors, be they local, national or foreign, have contributed to the recovery of the Phoenix market, he explains. He stresses that the Phoenix metropolitan area is a long-term growth market, and this factor, in addition to strong rental demand, creates good investments.
“Foreign investment in our real estate market is certainly not new. A number of foreign investors saw opportunities, and capitalized on them. That’s one of the reasons for the short supply right now,” Lotardo says. “Although some people are looking at this as a problem, I see this as an opportunity for the market to move in the correct direction.” The big issue is finding a happy compromise between prospective buyers and foreign investors in this self-correcting trend. According to Lotardo, investors are just one segment of the market between buyers and sellers, and Phoenix is making adjustments at this time. “As prices increase, that allows sellers to consider selling their homes that were previously underwater — allowing them to be buyers as well.”
RESPA Protections
2011 saw the passage of the federal Real Estate Settlement Procedures Act, intended to protect consumers from the unnecessarily high settlement charges stemming from certain abusive lending practices. “The idea was full disclosure and prohibition against kickbacks,” explains Stapp. While he doesn’t see it altogether eliminating dishonesty, because “moral hazard and principal-agent problems” are frequent in the real estate business, he does expect it to help reduce the incidence. The down side is, because of increased verification and paperwork requirements, RESPA “slows the process, requires considerable work, and leaves little margin for discretion, making it harder to qualify and actually close,” he says. This further irritates borrowers, lenders, sellers and pretty much everyone involved, who are hoping for financial gain. “Failed or delayed closing causes frustration for all, and frustrations cause complaints. There is no perfect fix,” he says. In addition, Stapp says the system tends to favor cash buyers and investors.
An additional proposal coming this year would reduce the involvement of the title and closing agents. Lotardo believes this would be disadvantageous to the consumer and lenders, noting, “Title escrow agents play a big role in the process, and removing that part of the process creates loss of efficiency, talent, [and the overall positives associated with the consumer experience].”
According to Lotardo, reactions over the past few years have created “over-corrections” in foreclosure and tax laws, and people are now hoping to moderate some of those modifications so that they are actually efficient and progressive.
Forecast for the Future
Stapp believes the Phoenix real estate market is on a steady path to recovery. His forecast is cautiously optimistic, and he admits that permanent health is primarily based upon employment. “The outlook for the next several months is more of the same, but likely to include a moderation in the rate of price increases. Gains will be based on specific locations, but the Phoenix area is definitely the most desirable sub-market,” he says. But job growth is critical, and the price of homes must be tied to what is affordable; prices cannot continue to escalate without higher-wage jobs being added to the market. New home construction will add necessary new inventory, and will create a healthier supply and demand system. “But we can’t yet build enough homes to create an absolute balance. We need new homes built to help create a fluid market again, but the cost of building a finished lot and a house has to be aligned with what buyers can afford,” he reiterates.
As to whether the appraisal process will work under the present employment and other conditions, Stapp admits matters are complex. “Another factor is healing personal balance sheets and [that] relates to lenders’ comfort in lending. This is still underway and will take a few years to fully resolve,” he explains.
“The scarcity of supply is also a controller on what is now in the market place,” says Bielli. “Now, you have a situation of contraction. There hasn’t been a lot of new development in the last five years. There’s also a market stabilization put in place with regard to foreclosures — homes on the resale market — and you’re starting to see price increases. … People are starting to see a gain, and are coming back into the market,” he says.
Phoenix is two years shy of a full recovery, says Stapp — presuming the economy at large remains stable, as do federal regulations, and there are no major global catastrophes. “What is done with mortgage lending, mortgage interest deduction and the secondary mortgage market is still somewhat unclear, and the resolution over the next two years will have a big impact. We still have a broken system, and it’s not being fixed rapidly, or at all in some cases,” he says. Still, Stapp believes Phoenix is headed in the right direction, and that, in itself, is hopeful.
Pollack is also cautiously optimistic about the future, and agrees that job growth and higher employment will help, as will credit availability. “The outlook for single-family housing, in relative terms, is quite bright. Commercial markets will continue to slowly improve. Both have a long, long way to go before they are near ‘B’-word territory. No bubble here, just a recovery,” Pollack says.
