For the first time in three years, the ASU-RSI (Repeat Sales Index) is showing an increase in residential prices: preliminary data for March show that year-over-year, prices for homes in the lower-price and foreclosure segments in Phoenix turned positive. Meantime, a pair of new indices is showing that the commercial market is continuing to decline and improvement will lag behind even after other parts of the economy turn up.

The commercial market information was gleaned from two new quarterly commercial indices released this week by Real Estate Professor Karl Guntermann, who calculates the ASU-RSI. The Commercial RSI (CRSI) will track office, retail, industrial and multifamily (five and more units); the two-fourplex RSI will track small residential investment properties of two to four units. The original ASU-RSI includes an index for the overall market, two indices that separate the foreclosure-related sales from the traditional, and a townhouse/condominium index. Combined, this suite of indices covers every segment of the Phoenix real estate market.

Residential: Important Milestones

The year-over-year comparisons for the overall residential market saw prices slipping another 9 percent in January (November was -17; December -13), with preliminary projections for February at -7 and March at -3 percent.

Hidden in the breakdowns, however, is a nugget of substantial good news.

In contrast to the overall 9 percent annual decline, the January to January decline for lower priced homes was 8 percent, but this swings to a 4 percent increase by March, writes Guntermann. Higher-priced homes, which had not shown significant slowing in the rate of decline until recent months, are looking at a projection for a 6 percent drop in March.

The foreclosure indices show a similar pattern. The prices of foreclosed houses declined at a 3 percent rate from January 2009 to January 2010 but the preliminary decline for February is 2 percent followed by a 5 percent increase in March, Guntermann writes.

Sales of non-foreclosed homes did not fare as well in the year-over-year comparison. In January prices slipped 17 percent, with projections for -19 percent in February and -14 percent in March.

Guntermann said that the turnaround in foreclosures reflects two years of substantial price declines and the increased demand from first-time buyers and investors. The continuing decline in non-foreclosures prices has more to do with weak economic conditions, especially in Phoenix, and the difficulty buyers face in qualifying for mortgage loans, Guntermann said.

Other developments in residential:

  • The overall median price for sales that were included in the January index was $125,000 but the preliminary figure for March is $132,000, almost back to the December 2009 level.
  • The median price for foreclosed houses in January was $115,200, up substantially from a low of $97,000 last May. The preliminary median in March is up only slightly from January and prices since October 2009 have been in the range of $115,000 to $120,000.
  • For non-foreclosed houses the median price was $155,000 in January, with a preliminary median of $158,500 by March. The March figure will be the first monthly increase in non-foreclosure prices since the end of 2007 and may signal the start of price stability throughout much of the housing market.
  • The decline in the townhouse/condo RSI increased slightly to -28 percent in January compared to -26 percent in December, with preliminary rates for the next two months of -26 and -19 percent.
  •  It appears that the most rapid declines (-36 percent) in the townhouse/condo market occurred last summer, but the best that can be said about townhouse/condo prices is that the declines appear to be slowing only gradually, according to Guntermann.
  • The median price of townhouse/condo units was $80,000 in January, with forecasted medians the next two months of $86,400 and $83,500.

Commercial: More Pain to Come

The new commercial indices use the same methodology as the residential RSI -- comparing sales and resales of the same property over time. The reports will be issued quarterly; this first report culls data from fourth quarter 2009.

The new indices show that the commercial sector is tied more directly to economic fundamentals, unlike the residential sector, which moved in response to speculative forces, lax lending standards and low interest rate, according to Guntermann. Thus the residential RSI began to rise during the 2001 recession, but the commercial side did not begin its climb until 2003 and remained strong until 2007 -- two years after the residential market peaked. During 2008, Guntermann said, all of the indices plummeted, but the residential RSI leveled off in 2009 while the commercial indices continued to decline. In fact, at the end of 2009, commercial prices were declining at an annual rate of 40 percent.

Perspectives on the CRSI and two-fourplex RSI from the report:

  • Volatility: Commercial prices peaked at an annual rate of 28 percent in 2006, Quarter 3 and slowed throughout 2007 before beginning a precipitous decline in 2009. While the decline in Quarter 3 was -38 percent, the decline increased only slightly by the end of 2009 to -40 percent. Commercial price changes lagged residential throughout the recent cycle. If this pattern continues, the fourth quarter slowing may indicate that commercial prices will start falling at a slower rate, which has been occurring in the residential market for almost a year. Annual price declines in the two-fourplex market were over 50 percent by the end of 2009 but also appear to be slowing.
  • TFEPS: The total forecasted earnings per share (TFEPS) series serves as a leading indicator of changes in the CRSI. It is likely that changes in a company's expected earnings as reflected in financial forecasts would be associated with changes in their demand for real estate, either through acquisition or leasing, and that the resulting price effect would be reflected in the CRSI. The changes in TFEPS for Phoenix-based companies may also proxy for broader changes in economic conditions that subsequently impact the Phoenix commercial real estate market ... A careful comparison of TFEPS and the CRSI shows that the change in the direction of TFEPS leads the CRSI by one to two years and is particularly clear beginning with the 2001 recession. It is a positive sign for the commercial market that TFEPS reached a turning point early in 2009 but with weak economic fundamentals and continuing refinancing problems, a clear reversal in the CRSI is not likely to occur until later this year ... The decline in the CRSI is exceeded only by the decline in the prices of two-fourplex projects, which were down by over 50 percent in the last half of 2009.
  •  Employment: Changes in Phoenix employment precede changes in the commercial market, typically by several quarters ... Growth in employment peaked at the end of 2005 compared to the CRSI which peaked almost a year later. The longer than normal turnaround in the CRSI relative to employment undoubtedly reflects the same speculative momentum that affected the housing market, including readily available financing. The recent unprecedented decline in both employment and the CRSI is apparent over the 20 years covered in the graph. If the historical pattern continues, a turnaround in the index will follow an improving labor market by several quarters.
  • Capitalization rates: Cap rates had been trending downward since the mid-1990s before starting a sharp decline in 2003 associated with the start of the current real estate cycle. Throughout 2006 cap rates were essentially stable as commercial values, as measured by the index, were appreciating rapidly. This means that rents or at least the stabilized or normalized rents used by appraisers were also increasing. Cap rates began to increase in early 2007 as talk of a recession became more widespread but commercial prices didn't peak until early 2008. Changes in both the CRSI and cap rates accelerated throughout 2008 and 2009 with the CRSI declining almost 50 percent from its peak and cap rates increasing well over 2 percent. By the end of 2009 both the CRSI and cap rates were back to their early 2003 levels.
  • Unprecedented declines: The extended period of relatively stable cap rates stands in contrast to changes in commercial prices, which peaked at an annual rate over 28 percent by the third quarter of 2006. Double-digit increases continued for another year but by early 2008 prices were declining with dramatic decreases occurring throughout much of 2009. Increases in cap rates along with the weak Phoenix economy suggest that commercial prices may continue to decline at unprecedented rates for the foreseeable future.