Real Estate’s Far Reach to Continue to Pinch

May 27, 2010 | 1 Comment

by Conor Dougherty
Monday, May 10, 2010

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It looks like the US economy is taking longer than anticipated to recover due to the surplus of foreclosures and the large inventory of homes. The Wall Street Journal just came out with this great article that explains the details…Read on-

Highflying property prices drove the most-recent economic boom, and a collapse in real-estate values hammered it back down. Now, as the economy struggles to regain strength, real estate is expected to continue to act as a brake, rather than an accelerator.

Despite clear signs of revival in the larger economy, including upturns in manufacturing and consumer spending, the nation’s market for homes and office buildings remains mired in foreclosures and oversupply. That imbalance will be worked out over time, but in the meantime, it is slowing the recovery in myriad ways.

Here’s how it breaks down:

Less construction means fewer jobs. Construction is a big employer and one of the better-paid sectors for men who lack a college degree. The sector has shed 2.1 million jobs from its peak in March 2007 to April 2010. The 5.6 million construction jobs that are left comprise 4% of U.S. jobs, down from 6% when employment peaked in December 2007.

With the glut of houses, offices and malls already pressuring the real-estate market, many of these jobs will not come back for a while, putting added pressure on unemployment even as growth resumes.

Indeed, construction spending is running 13% below its year-ago level and about 25% below the boom-year peak.

Home owners who once felt rich are feeling poorer. Throughout the boom, consumers used their home equity to borrow and spend as they watched housing prices soar. The ratio of dollars taken out of homes to total personal income—a gauge of how much consumers are pulling out of their homes relative to how much they make in wages and other income—fell the last three quarters of 2009. During the boom years, that ratio got as high as 9% nationwide, according to Moody’s Analytics.

While real-estate prices have stabilized, they are unlikely to regain prerecession values for years. That has left many consumers with a pile of debt but not much home equity to be used for investment or spending, a big reason why economists believe recent gains in consumer spending aren’t sustainable.

“The housing market, since it was the epicenter of the crisis, is also central to the feeble recovery,” says Ethan Harris, an economist at Bank of America Merrill Lynch.

Small businesses aren’t borrowing as much. While bigger companies can access the now-recovered market for bonds and other debt, many smaller companies—which are key job generators—use the value of their own property to secure bank loans. As the value of those holdings has fallen, so too has their ability to get loans, crimping investment and hiring at a time when the recovery is gaining steam.

Some 49% of small businesses own at least part of the commercial buildings in which they are located, and the majority of them have mortgages, according to the National Federation of Independent Business. But as real-estate values have fallen, so has this source of equity, limiting how much a bank can lend them.

U.S. nonfinancial companies had $6.3 trillion in real-estate assets at the end of 2009, down 33% from 2007, according to the Federal Reserve. That drop is a big reason why corporations’ total net worth fell to $12.9 trillion from $15.9 trillion over the same period.


With the value of collateral so depressed “the ability for many small employers to borrow will be constrained precisely as sales begin to strengthen and new investments are warranted,” wrote the National Federation of Independent Business in a recent report on small-business credit conditions.

Lower real-estate values translate into lower property taxes, crimping government spending. State and local governments employ 20 million police officers, teachers and other employees, roughly 15% of the work force and more than in all of manufacturing. But much of the money to provide services and pay employees comes from property taxes, which depend on property values. Even as the economy and job market recover, Local governments are cutting employees as they grapple with the worst budget deficits in a generation.

Property taxes continued to grow through the recession and recovery, in part because local governments calculate the levy based on property assessments that are often years old. Property taxes grew 5.7% to $170 billion in the last three months of 2009 versus the same period in 2008. That won’t last as tax assessments catch up with reality.

In California, one of the first states into recession, Santa Barbara County saw its 2009 property taxes decline for the first time since 1978.

Property taxes “have only just begun to slump, meaning that cities and other localities will be contending with increasing budget pressure for the next several years,” writes the Brookings Institution, a left-leaning Washington think-tank, in a recent report on local government.

Real estate itself is but a small share of the U.S. economy, but its tentacles are far-reaching.

Source: Wall Street Journal


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