Arizona's economy: Recovery at a glacial pace

December 01, 2010

Arizona's economic recovery will continue to move at a glacial speed in 2011 -- but at least it's moving. The coming new year will see an increase in job creation, a rise in population and even a modest increase in single-family home permits. But the consensus among economists at today's 47th Annual Economic Forecast Luncheon, co-sponsored by the Department of Economics at Arizona State University's W. P. Carey School of Business and JPMorgan Chase, is that Arizona's recovery will continue to be far less robust than economic rebounds of the past.

"Arizona was much harder hit in this recession than the rest of the country," said Lee McPheters, director of the JPMorgan Chase Economic Outlook Center at the W. P. Carey School of Business in an interview before the luncheon. "Overall the U.S. lost about 6 percent of jobs, while Arizona lost 11 percent of jobs and the Greater Phoenix area lost 12 percent of jobs. So, by that measure, Arizona's problems were twice as large as the average state."

Elliott Pollack, CEO of Elliott D. Pollack & Company in Scottsdale, presented the real estate outlook. "The good news is that the worst is over, but it's going to be a painfully slow recovery," Pollack said in a pre-event interview.

Job growth

According to McPheters, hampering Arizona's growth in 2010 has been:

  • Consumers' focusing on paying off debt rather than spending
  • Corporate profits improving but hiring deferred
  • The expected resurgence in single-family housing did not develop
  • Home prices have not yet stabilized
  • Small businesses facing tight credit conditions and weak demand
  • Stimulus programs ending

In terms of job creation, Arizona employment is expected to increase by 47,800 jobs in 2011, following three straight years of losses. The projected rate of growth for 2011 is 2 percent. That's about double the rate of employment growth anticipated for the nation as a whole, but well below the state's long-term average of 3.7 percent.

"So, three years after the recession began (December of 2007), we are finally at the threshold of recovery," McPheters said. "We expect moderate job growth -- maybe 2 percent to 3 percent growth -- in the next couple of years, and it will probably be 2013 before the Arizona economy returns to an employment level of 2.6 million workers, the number employed in December of 2007."

In addition, the state's unemployment rate will remain above the 9 percent mark throughout 2011.

Still, even with Arizona being at ground zero of the burst housing bubble that dragged the rest of the nation into recession, the employment situation in the state has shown a marked improvement.

"For all of 2009, at the deepest point of the recession, only Nevada had weaker labor market conditions, and Arizona ranked 49th among the states in job growth (or losses)," McPheters said. "But in just the past couple of months, Arizona's overall position is improving. The state ranked 12th based on October job creation in the 50 states. And in September, Phoenix added 27,400 jobs compared to the year before. Phoenix is the now the second-fastest growing metro area."

Arizona's job performance in 2010 compares favorably to that of the rest of the region. Texas tops the West and the nation in job creation. Following Texas in the West, Arizona had the second-largest number of new jobs. For next year, Arizona and Texas are projected to see the greatest percentage gains in employment.

Industries expected to create jobs in 2011 in Arizona include health care, professional and business services, trade, and leisure and hospitality. Manufacturing has lost jobs on an annual basis for four consecutive years and is expected to continue to shrink.

Real estate

The real estate and housing markets in Arizona remain weak in 2010, with single-family housing permits expected to be down 5 percent, marking a fifth consecutive year of declines. Single-family housing permits are expected to finally improve next year, with an anticipated increase of 25 percent. However, that increase stems from a base of 12,000 units in 2010, totaling just an additional 3,000 units. Compare that paltry number to the 80,000 annual permits handed out at the peak of the housing boom.

"Last year at this time, there was optimism about Arizona housing, but the growth never came," McPheters said. "It looks like 2010 single-family building won't even reach the level of 2009, which was the worst year of the recession. So most analysts are cautious right now about housing."

One of those cautious analysts is Pollack. He lists the following as reasons why the state's housing market is showing only the slightest signs of improvement:

  • Tougher underwriting standards on mortgages -- Consumers wanting to get a home mortgage have just two choices: conforming and FHA loans. The days of option ARMs, subprime and alt-A mortgages are over, and even jumbo loans are difficult to get. In addition, lenders are requiring much higher credit scores and income from potential homeowners. Not surprisingly, this has drastically cut down on the number of people who can now qualify for home loans.
  • Up to 51 percent of the homes in Arizona have negative equity -- That means, at best, the homeowners will not be able to sell their current homes and move into larger houses. At worst, people will simply walk away from their homes, ruining their credit and taking themselves out of the home-buying pool for years to come.
  • Previous loan modifications have mostly failed -- Federal agencies and private lenders have tried to modify loans in order to stave off foreclosures. But, according to Pollack, about 65 percent of all loan modifications fail within one year of the modification, and 25 percent fail within three months.
  • Foreclosures remain high -- Pollack says more foreclosures could be in the future as banks bow to the inevitable and start seizing homes from delinquent owners.
  • Option ARM resets do not peak until next year -- According to Pollack, there are some estimates that up to 90 percent of option ARMs are negatively amortizing. Combine negative equity with higher mortgage payments once the ARMs reset and you have a recipe for even more home loan defaults.

With the Valley's housing market holding up to 50,000 to 75,000 excess housing units, Pollack said supply and demand might not get back to normal until 2014.

Meanwhile, the commercial real estate market in the office, industrial and retail sectors remains bleak.

"Those markets are slow because the economic recovery is slow, and because it will be a while before we create a sufficient amount of jobs to where there will be much demand for those product types," Pollack said.

In the office market, the negative absorption rate was even worse in 2009 than in 2008. In 2010, the absorption rate is slightly positive, but given the lag between breaking ground on a project and when it is completed, the change in inventory has exceeded absorption this year and vacancy rates are higher.

Pollack foresees the office absorption rate to be higher in 2011 and 2012, while inventory declines. The reason? Currently, there are no multitenant office buildings under construction, and no significant spec-multitenant building is expected for the next three to five years.

In the industrial market, the vacancy rate in Phoenix is the highest in the nation. Pollack said absorption is slightly higher than the change in inventory in the first three quarters of 2010, and there is next to nothing being built or planned. So, while absorption will continue to rise, a full recovery in the industrial market is still years away.

As for retail, since the market follows rooftops, a significant recovery won't take place until the housing market stabilizes, thus necessitating more retail construction.

The only real bright spot in the commercial real estate industry is in multi-family housing. The vacancy rates in apartment houses are dropping; unfortunately it's because of the number of people who lost or walked away from their single-family homes.

"The good news is there is a boom out there," Pollack said. "But that boom is out there in 2014 or 2015."

Population growth

Arizona has long relied on population growth to spur an economic recovery. But, McPheters said, with the housing market crippled across the country, people in other states can't sell their homes and move to Arizona. As a result, he expects the state's population will increase by less than 2 percent in 2011. Five or six year ago, that increase exceeded 3 percent, which is three times faster than national population growth.

"What appears to be happening, is that we are attracting young newcomers, people in the 20-29 age group, that are not homeowners; they are not locked into their current housing situation and they are not well established in their career path yet," McPheters said. "If these newcomers are well-educated and bring current job skills with them, this is good for the state. On the other side of the equation, there may be people leaving the state also, but we don't have a good way to measure these flows. All in all, population growth should be stronger in 2011 than in the past couple of years, but still below the pace we need to get the economy going in high gear."

Personal income and retail sales

In 2009, Arizonans saw a 2.3 percent drop in their personal incomes, the first decrease since records started being kept. In 2011, McPheters said personal income is projected to grow by 3.5 percent. That's a far cry from the 13.4 percent increase seen in 2006. With income still growing slowly, McPheters said, consumers will remain cautious in their spending. Not surprisingly, retail sales remain anemic for the fourth consecutive year and are expected to grow by a mere 1 percent in 2010. However, with Arizona's economy starting to generate jobs and personal income showing signs of life, McPheters said, retail sales are forecasted to rise by 6 percent in 2011. But, as a reminder of just how far the Arizona economy has fallen, total retail sales in 2011 will be $56 billion, more than $7 billion below 2007. That, of course, will present a serious challenge to the state's budget and the Legislature.

"The one, single force that will speed Arizona's recovery is overall strong growth at the national level," McPheters said. "We don't expect to see that in 2011. There is not going to be a lot of job growth and unemployment rates will stay high. Every state is going to be focused on jobs and being more competitive. The strategies needed [to recover] are mostly long term and anybody who has studied economic development can tell you what they are. Arizona needs a top-notch educational system, modern transportation infrastructure, competitive (not necessarily the lowest) taxes, and a general pro-business regulatory environment."