The High End of the Market Isn't Immune After All

Zillow recently published its latest Homeowner Confidence Survey. According to the results, 70% of western region homeowners believe their homes lost value during the last year. Evidently, perception is catching up to reality, but there is still a sizable gap. Zillow estimates that, in fact, 90% of western region homes lost value. And judging from the Case Shiller indexes, the loss of value was substantial. Only one western market (Denver) fell by less than 10%, and five of the eight markets fell by 25% or more. The Zillow survey suggests, in other words, that at least 20% of western region homeowners are in a state of denial.

Some of those mistaken homeowners may live in San Francisco's high-end neighborhoods. Once a week, I hear someone say, "Sure, prices are falling, but the high-end of the market is holding up." I'm not sure why people are so determined to believe that, but it turns out that it's not true. Take a look at the chart, below, which shows an index of median prices for single-family homes in two of San Francisco's real estate districts.

The blue bars represent District 7, which comprises some of the City's most expensive neighborhoods, including Pacific Heights, Cow Hollow, and the Marina. The purple bars represent District 10, which comprises some of the City's least expensive neighborhoods, including Bay View, Excelsior, and the Outer Mission. Both data series are indexed to a value of 100 in 2000.

Contrary to popular belief, high-end prices have in fact fallen, by about 8% between 2007 and 2008. What's more interesting, however, is that on a cumulative basis, the high-end neighborhoods haven't done any better since 2000 than the low-end neighborhoods. The low-end neighborhoods have given up more of their gains recently, but those gains were much larger to begin with.

Another way to show the similarity between high- and low-end neighborhoods (at least as far as market performance) is by considering sales volumes. Take a look at the chart, below, which shows an index of sales volumes for the same two districts as before.

Once again, the blue bars represent District 7 (high-end) and the purple bars represent District 10 (low-end). In this case, however, each series is indexed so that its average value over the 15-year period is 100.

Except for a couple of years in the mid-1990's, the two indexes have tracked each other closely. In particular, both indexes peaked in 2004 and have declined by 30%-35% since then. (It's noteworthy that low-end sales volumes actually rose slightly in 2008.)

It seems, then, that the high-end neighborhoods are not a class unto themselves, but are, in fact subject to the same economic factors that affect the rest of San Francisco. Nonetheless, many homeowners in these neighborhoods remain convinced that their homes are special. Zillow's survey results contain a striking (and funny) illustration of this aspect of human nature. 48% of homeowners think their local markets will decline in the next year, but only 30% believe the same will happen to their own homes.

Note: The supposed immunity of high-end neighborhoods looks like a reincarnation of an earlier piece of wishful thinking, namely, the suggestion that a weakened US dollar would induce wealthy foreigners to prop up the San Francisco housing market. No doubt, the proponents of that theory were thinking about the high-end of the market.

Architecture Billings Index Foretells Big Drop in Construction Spending

This is the kind of data series that I like to monitor. The American Institute of Architects publishes an index of industry activity, the so-called Architecture Billings Index. They announced yesterday that it hit an historic low of 33.3 in January. To put that into context, any score below 50 indicates a reduction in billing activity. Until the current crisis, the index had never fallen below 40.

The billings index is a pretty good leading indicator of non-residential construction activity. According to a 2005 study by AIA economists Kermit Baker and Diego Saltes, the billings index leads construction spending by nine to twelve months. I did a quick search for historical data so I could do my own analysis, and ran across this posting on Calculated Risk. I've reproduced one of the key charts below.

The red line (right-hand axis) is the billings index. The blue line (left-hand axis) is the percentage change in private, non-residential construction spending over the trailing twelve-month period. It's clear that the two series track each other fairly closely.

The billings index has fallen by 30% in the last twelve months. (See the updated chart, above.) Calculated Risk points out that a 30% fall in construction spending would be equivalent to $128 billion. That's small compared to the overall economy, but it is significant when compared to any number that's relevant to the real estate industry. (You can read the Calculated Risk posting for more insight.)

Bay Area Unemployment Still Rising Sharply

Unemployment in the nine-county Bay Area hit 7.3% in December. That matches the high point of the 2001 recession (which was actually reached in June of 2003). It's also the highest rate in the last 19 years, going back to 1990 (i.e., the beginning of my data series).

The national situation isn't any better. In its remarks yesterday, the Federal Reserve said that national unemployment will probably increase to 8.5%-8.8% by year end, and probably won't return to the current level (7.6% in January) until 2011.

From the looks of the chart above, I'd say we'll be doing well if we can keep unemployment from rising by more than a percentage point over the next year. Fed Chairman Ben Bernanke seems to agree with that sentiment, saying that unemployment will climb to 8.0% "for sure."

Fed Says Recession Will Be "Unusually Prolonged"

My last posting referred to a paper by Carmen Reinhart and Kenneth Rogoff, in which they said that recessions stemming from financial crises are typically twice as long as 'ordinary' recessions. The Federal Reserve weighed in on the issue today, saying that recovery from the current crisis will be "unusually gradual and prolonged." My guess is that the Fed is reading the same tea leaves as Reinhart and Rogoff.