PSAZ | Metro Phoenix Economic Snapshot | February 2023 – 2

GAMBLING ON RECESSION ODDS

Elliott D. Pollack & Company 2023 Economic Outlook

In the fight against inflation, the Fed delivered seven interest rate hikes in 2022 which was the fastest increase of this magnitude in history and pushed borrowing costs to a 15-year high. This is all by design. Higher interest rates discourage spending by both businesses and consumers and reduced spending lowers economic activity. Decreased economic activity will lower inflation.

But the Fed is in uncharted waters. They have never tried to induce a recession in such a tight labor market. In 2022, the U.S. labor force grew by 2.6 million workers, there were 4.5 million jobs added and the current unemployment rate of 3.5% is the lowest in 53 years. But there are also presently 10.3 million job openings across the U.S. and only 5.7 million people unemployed. Fierce competition for employees has driven up wages and that is when inflation starts to stick around for a while because consumers are able to afford the higher prices for goods and services.

This huge gap in labor supply is also at the core of the concept that the Fed can achieve a “soft landing” for the economy. The idea is that the reduction in economic activity can deplete the gap of unfilled jobs and minimize actual job losses (current projections for the recession still predict 1.5 million to 2 million job losses across the country). So far, only job increases have occurred, meaning that there is little evidence so far that the interest rate hikes have slowed hiring. Wage growth has slowed though, which is a promising indicator in the fight against inflation.

The real estate market is taking the brunt of the hit delivered by Fed interest rate hikes. New home permits were down 18% across the State of Arizona last year and we believe they could decline another 20% in 2023. We also believe housing prices could fall another 10-15% in 2023. This will provide a modest reversal to our affordability crisis. But it will be nothing like the 2008-2009 housing crash. Home prices skyrocketed by over 80% in the last three years through May 2022. So, a 10% decline only puts us back to May 2021 prices and a 15% decline puts us back to March 2021 prices. That limits the number of homes that may experience low or negative equity, which was a widespread issue back in 2008. In addition to that, there were much stricter lending practices this time around, no subprime loans issued, and no excess supply of homes.

The consensus odds of a recession this year are at an all time high, though the timing, length, and severity are still being debated. It is way too soon to tell, but we have broken down the odds as we see it today into three scenarios.

1. We give the “Best Case” scenario a 20% chance. In this scenario, things work out for the Fed as planned. A soft landing. Inflation is brought back under control quickly and smoothly and we all live happily ever after.

2. We give the “Base Case” scenario a 50% chance. In this scenario, we are in for a rough ride, but the recession is short and shallow. It will take some time, but we get through it and the economic situation improves in 2024.

3. We give the “Worst Case” scenario a 30% chance. In this scenario, things get rocky. We end up with the actions of the Fed, fiscal policy, or black swan event causing things to be worse than anticipated. Geopolitics are hard to predict and have substantial impacts.

Our latest forecasts for the economy in 2023 have taken into consideration a slowing economy over the next 12 months. We still believe Arizona will be a preferred destination for new residents and industry, but our expectations for new employment have been tempered by the expected recession. As previously mentioned, new home development is also expected to decline substantially with the combination of affordability issues and higher mortgage costs reducing demand.

GREATER PHOENIX ECONOMIC FORECAST

POPULATION

1.9% INCREASE 2022

1.7% INCREASE 2023

EMPLOYMENT

3.9% INCREASE 2022

2.0% INCREASE 2023

RETAIL SALES

8.6% INCREASE 2022

3.4% INCREASE 2023

SINGLE FAMILY PERMITS

-27.5% DECREASE 2022

-20.0% DECREASE 2023

“odds of a recession this year are at an all time high”

Residential Real Estate

Tina Tamboer, The Cromford Report

In 2022, the Greater Phoenix housing market experienced a dramatic shift in demand fueled by the highest rate of mortgage rate increases since the early 1980’s. Normally we provide annual price measures for this report, which encompass an entire year of sales, but they are slow to reflect rapid price shifts and appreciation in the first half of 2022 was vastly different from the second half. To accommodate for this, below are the year-over-year price appreciation measures showing both complete year and December only comparisons through the Arizona Regional MLS (ARMLS):

By comparison, demand was also 28% below normal for the end of December. Supply declining to meet low demand brought the brief 4-week Buyer Market that had developed in November to an end, at least for now.

If this Balanced Market holds, prices should stabilize in the first half of 2023. December contract prices, which will be reflected in January closings, may show the bottom of the market but we will not know until the end of March. Having so few closings put massive strain on an industry that had grown over the years to support a higher level of sales. A balanced market is of little help to the throngs of people who were laid off in lending, title and escrow, inspections, appraisals, and other service industries that had to shrink operations within a short 6-month period to survive.

Despite the pain the industry has endured, most sellers are still walking away with significant profits as 65% of resales in the MLS have been owned for at least 2 years. Even after a 12% decline since May, sellers with at least 2 years of ownership averaged 26% in appreciation and those with at least 5 years of ownership saw 72% or more. This put most sellers in an equity position to accommodate rate buydowns and closing cost contributions for buyers, as reflected in 50% of December sales involving incentives with a median concession of $9,400.

In the first half of 2022, prices rose 13.2% from January through May while mortgage rates rose from 3.45% to 5.52%, spurring a market shift in demand. In July’s issue, we wrote that if mortgage rates were to remain high it would be reasonable to expect a 10-15% decline in sales price measures, producing a 0% year-over-year return by December. In the second half, mortgage rates were over 6% for the last 3.5 months and even surpassed 7% in October. As expected, the average sales price per square foot declined 12.4% from the peak of May to the trough of December, putting the year-over-year December change to -0.8% and essentially erasing all appreciation from the first half of 2022.

The second half of 2022 saw builders and iBuyers take a beating, as normal home buyers were back in the driver’s seat and cash investors took a back seat. Appraisals, inspections, and affordability became important once again, but a family making the median income could still only afford 22% of what was selling in Greater Phoenix1. The normal range is 60-75%, and without cash speculators sales in the second half plummeted to levels not seen since 2008. Offset by high sales volume in the first half, 2022 ended with 80,989 MLS sales; 23% below 2021 and comparable to 2014-2015.

Supply of homes continued to rise until October when active listings peaked at 19,643, up 331% from March. However, fewer homeowners chose to sell as prices declined and new listings became nearly as scarce as new contracts by November. Supply began to drop. By the end of December, supply had declined 20% to 15,731; 203% higher than 2021, but still 27% below what supply should normally be at this time.

ANNUAL SALES RATE

Going forward, the first quarter of 2023 promises more buyer activity as Arizona kicks off its peak season with Super Bowl LVII, The WM Phoenix Open, Barrett Jackson, Spring Training and more. Seller-paid rate buydowns and closing costs will continue to be a part of negotiations through the first quarter to counteract high mortgage rates, which remain volatile and difficult to predict. There are good reasons to expect rates to decline in the first half of 2023, to what degree is a source of debate. If they remain above 6%, supply and demand will remain unremarkable. If rates drop as low as 5%, the market could rebound within a matter of months. Stay tuned.