Is this housing market turning up the heat, or having the next meltdown?
The Phoenix-Mesa-Scottsdale, AZ Metropolitan Statistical Area (Phoenix MSA) has been a high-performing market and a favorite amongst investors since the last recession. It has been red hot in terms of population, job growth, rental and price appreciation over the last five years but rolling virus concerns, economic shocks, and unpredictable government stimulus have changed the dynamics of the real estate market.
POPULATION GROWTH
The 2019 Census/ACS data shows the Phoenix MSA is the 11th largest MSA in the U.S. with nearly 4.95 million residents. The metro area added 100k residents between 2018 and 2019 (a 2 percent increase) and had the 4th largest five-year increase with nearly 460k new residents (a 10.2 percent gain).
JOB MARKET
The Phoenix MSA economy is the 16th largest in the U.S. by GDP. It has surged in population and job growth since the last recession. The favorable business climate with low income and property taxes have helped Phoenix become one of the fastest-growing economic markets in the country.
According to the BLS MSA-level Employment Report, between February and June 2020 the Phoenix MSA has lost nearly 7.6 percent or 170,900 jobs. Some job industries have been more resilient, but overall represents a setback of nearly all jobs gained over the last three years.
UNEMPLOYMENT
The Phoenix MSA hit a low unemployment rate of 3.6 percent in December 2019. Due to shutdowns, the unemployment rate spiked to a record high 12.5 percent in April, surpassing the previous record of 10.4 percent in 2010. Reopening the economy has restored many temporary layoffs, bringing the unemployment back down to 8.3 percent in May.
A 10X spike in COVID-19 cases between June and July have stalled the recovery temporarily. June unemployment has risen to 9.7 percent, partially due to large layoffs in the government sector and slowdowns from the second wave COVID-19 resurgence. As of mid-August, the case counts are returning to May numbers of ~500 cases/day, which should help get the recovery back on track.
HOUSEHOLD INCOME
According to 2018 ACS data, the various industries in the Phoenix MSA provide a median household income of $64,427, ranking the metro 82nd in the country. Incomes are slightly above the national median income of $63,688. The Queen Creek/Gilbert areas to the south, Litchfield Park/Waddell to the west and most zip codes north of Scottsdale have incomes above $80 thousand. Metro incomes have enjoyed a 4.7 percent increase vs. 2017 ($61,500) and a 15.2 percent increase over the 2013 household income of $51,850.
VALUES –VS– INCOME
The multi-index trend shows the significant ramp and brutal crash of home values in the Phoenix MSA (blue line) between 2005 and 2012. The Phoenix market was one of the most severe cases of subprime lending practices, in less than two years the market gained nearly 40 percent of perceived value.
However, it was also one of the first markets to top out in mid-2006 at just over a $300k median price, eventually losing over 50 percent of value in the recessionary period. Since the lows in late 2011, the market has again doubled in price, and recently surpassed the 2006 peak.
Rental rates for three-bedroom single-family homes (orange line) had only a minor decrease of -6.5 percent over the recessionary period yet held the values around $1,100/month from 2009 to 2014. In 2015, the rental market turned upward alongside the home price trend, rising an average of 9 percent per year.
Income growth (teal line) has been strong in the last five years at 4.6 percent YoY, but is beginning to flatten. Employment (red line) has taken a sharp turn downward, which will impact rent and home prices if the recovery remains slow.
HOME PRICE METRICS
Coming into 2020, Phoenix SFR home prices have been rapidly rising, supported by the large population increase and robust economy creating new jobs and wage increases.
As of June 2020, the median single-family home value in the Phoenix MSA was $325,000, a 5-year increase of 40 percent and averaging over 8 percent year-over-year growth since 2012.
The Phoenix MSA is third in the country for new single-family construction. The Census Building Permit Survey shows 21,300 total unit permits and 13,500 SFR permits YTD through June 2020.
Seasonal and new-buyer demand from historically low interest rates, plus below average inventory, has led to home price increases between June and July of over 2.5 percent.
Phoenix MSA Home Price Forecast through 2021
The historically low interest rates and comparatively high rental prices will continue to motivate buyers to compete for available inventory through the fall and winter. Prices will remain supported in the near term due to reduced inventory, low interest rates, seasonal demand, and buyer motivation towards single-family properties in more suburban areas.
However, any further resurgence in COVID-19 cases in the fall-winter flu-season period could restrict the economy and slow purchase activity. Those who do not qualify for a forbearance extension or loan-mod may affect prices by adding inventory at discounted prices.
Risks include tighter lending restrictions, a slow recovery for the job market, new-buyer attrition, and increasing defaults from non-GSE loans. Buyers and investors will be expecting to find deals at a discount, and this sentiment will put downward pressure on prices.
2020 (H2) SFR Housing Price Forecast: +2 percent to +5 percent
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2021 Phoenix home prices should remain stable if COVID outbreaks remain controlled, leading to a return in jobs. Real (non-stimulus) income will stay flat or decrease slightly as the economy ramps up. Mortgage interest rates are predicted to remain low through next year, and any dip in prices should encourage demand from both homebuyers and investors.
Demand will stay elevated in the suburban areas, while demand in the more populous areas will be muted. If interest rates climb, this will be a negative factor for the market by slowing purchase activity.
Other risks for 2021 include variability around expiring forbearance and eviction policies. Once the consumer protections expire, spikes in foreclosures and evictions will have a negative effect on prices.
2021 SFR Housing Price Forecast: -5 percent to +5 percent
Disclaimer: The variability around this forecast is wide and dependent upon data available as of June 2020. The severity and duration of the COVID-19 epidemic, as well as the response of the public and policymakers, continues to change daily.
RENTAL RATES
Phoenix has been the hottest market for single-family rental price appreciation over the last five years, boasting the #1 increase in rent prices of 45 percent. As of June 2020, the median three-bedroom, SFR home in the Phoenix MSA is $1,685/mo. Year-over-year change for a three-bedroom detached SFR is up nearly 5 percent, which is an $85 annual increase.
Across the metro, zip-code level three-bedroom SFR rents have a wide range of $1,300 to $2,750. Higher priced areas have seen moderate appreciation of 10 to 20 percent, while less expensive areas have much larger increases of up to 35 to 50 percent.
Using current median housing prices of $325k, first time buyers of an FHA loan with only 3 percent or $10k down could expect to pay around $1,480 with PMI. Loan requirements of 30 percent of income would require $60k/year to qualify. With taxes and insurance, it would cost around $1,750 to $1,850/month.
With all-in house payments only slightly more than rent, the income requirements could be pushing renters to buy in this environment. Landlords requiring income to be 3x rent would require $62k/year of income, which is slightly above the income reqs for purchasing a property.
Affordability issues are a growing concern. In a 2019 study, the NLIHC stated Arizona now has the third most severe affordable-housing shortage in the country. For every 100 extremely low-income people in the state, there are only 25 potential places they could afford to live.
Even with aggressive rent increases over the last several years, the Phoenix MSA has a rent-to-income ratio of 32.5 percent for SFR properties, slightly above the national average of 32 percent. Rent-to-income ratios near central Phoenix, Mesa and Glendale range between 35 percent and 50+ percent, as these areas have a larger segment of low-wage earners. Suburban areas show a moderate rent-to-income of 20 to 30 percent.
WHERE DO RENTS GO FROM HERE?
Phoenix Rental Rates Prediction 2020
Rent prices were overheating before the pandemic and are beginning to slow. The aggressive price increases have increased rental listing days on market by 25 percent YoY through June.
Anecdotal reports from many of the large institutional firms have reported excellent rent collection from their SFR portfolios through June. However, smaller landlords have begun reporting non payments on 1/4th of their properties, partly due to limited work-out plans they can offer tenants.
The governor of Arizona has stopped COVID-19 hardship related non-payment evictions through October, but all other eviction policies may still be enforced. Eviction policies and the extension of increased unemployment benefit could lead to a significant number of vacancies unless federal extensions are passed soon.
Risks stem from the large number of lower-income jobs affected by the spiking unemployment, and tenants may struggle to keep up with payments. Increased evictions will add to vacancies and lower overall demand. Mid- to high-priced rentals will see a drop in demand as some areas are less expensive to own than rent. Unemployment may remain elevated, reducing qualified tenants and putting further downside pressure on rents.
2020 SFR Rent Price Forecast: -3 percent to +2 percent
Our 2021 forecast is cloudy, with many unpredictable variables in play. Until employment and wages recover, single-family rental rates may face a shorter but similar stagnant appreciation period as seen between 2010 to 2015. If the virus issues abate and all segments of businesses can return to full capacity, this will help rental prices recover. However, in order to support higher rents, wages not only need to recover but also increase above current levels, which could take several years.
Demand will stay elevated for single-family rentals as renters move away from multifamily units. The increase in demand may be equally balanced by increased inventory from Build-to-Rent developments, and renters in a good financial position will convert to buyers.
2021 SFR Rent Price Forecast: -5 percent to 0 percent
CONCLUSIONS
No doubt the Phoenix single-family investment market has been hot in the past several years. It has been a favorite target for investors since the last recession for several reasons, including strong equity and income appreciation supported by rising population, job growth and wage increases.
On the other hand, being the #1 market for rent price increases may not be ideal when nearly 10 percent of the workforce is suddenly unemployed. Rent prices were already reaching an inflection point before COVID hit, and low interest rates have created an environment where it is cheaper to own than rent for many areas of the market. The Phoenix SFR rental market is currently overheated and needs a cooling period to get the economy back on track.
Even if there is a moderate pullback in the next 1-2 years, we don’t foresee a meltdown like the last recession. Owners have a record amount of equity built up, and a myriad of government programs to work with borrowers and mitigate another foreclosure crisis.
Bottom line, Phoenix has good fundamentals but is currently presenting a challenging environment for cash flow investors. Low cost, high yield opportunities are scarce due to the limited inventory and new-buyer demand. Prudent investors may want to wait for the forbearance period to expire and look for distressed sales next spring.
Fred Heigold III is the senior data analyst at Altisource® / RentRange®, an industry leader in market data and analytics for the single-family rental housing industry.
