Economic Notes: NJ Economic Update
1/27/2009
The following testimony was presented on January 26, 2009 by Patrick J. O'Keefe, J.H. Cohn LLP's director of Economic Research, to the New Jersey State Senate's Committee on Economic Development. Click here to view the accompanying presentation.
Mr. Chairman, members of the Committee, thank you for the opportunity to participate in this hearing. My remarks focus on current and future economic conditions in New Jersey, particularly the State’s real estate markets.
Macro-Economic Context
According to the National Bureau of Economic Research, the U.S. economy entered recession in December 2007, ending a 61-month expansion.
Nevertheless, gross domestic product (GDP), the total of all goods and services produced in the U.S., grew in the first half of 2008 (Chart 1). This was largely due to the Federal tax rebates and other stimulus measures enacted early in 2008 to counter the impact of the “credit crisis” on the general economy.
Once the rebate checks were spent, however, the economy resumed its contraction, turning negative (-0.5%) in the third quarter of 2008.
Even with the stimulus, employment declined throughout 2008 (Chart 2) and the U.S. lost a total of 2.6 million jobs over the year. Concurrently, joblessness rose and the national unemployment rate hit 7.2%, a level last seen in 1993.
With consumer confidence falling to record lows, personal consumption expenditures fell at an annualized 3.8% in 2008’s third quarter.
Consumer spending accounts for 70% of GDP. Therefore, when the consumer gets tired the rest of the economy goes to sleep. So, after spending their rebates, fatigued consumers pulled the covers over their heads (retail sales have dropped for six consecutive months), and the rest of the economy went comatose.
While we will not get GDP numbers for the fourth quarter of 2008 until later this week, based on the data for the past few months I estimate (see Chart 1) that the U.S. economy declined at an annual rate of 4.8% in 2008’s last three months.
Even assuming rapid enactment of a well-crafted Federal stimulus package, GDP can be expected to shrink, though at a decelerating rate, for the remainder of the year. Recovery, when it comes, will be slow and erratic.
There are several reasons for this, including inter alia:
• Continuing distress in the global financial system;
• Slowdowns in most advanced economies and major emerging economies;
• Declining asset values (including real estate); and
• Total outstanding debt, particularly among U.S. households (Chart 3).
There is much in current circumstances that brings to mind the 1970s, with its serial downturns.
New Jersey Economy
New Jersey grew steadily through the first seven years of this decade, with real GDP (Chart 4) up an average of 2.1% per year. 2008 data is not yet available.
While the State’s employment picture (Chart 5) was mixed through 2007, it turned negative in 2008, with New Jersey losing an estimated 63,000 jobs. The bulk (55%) of the losses were in the private service-providing sectors, which historically have been cyclically resilient.
Due to the combination of a shrinking jobs base and a growing labor force (+86,800 over the year), the number of unemployed rose by 136,900 (+72.8%) and the unemployment rate rose to 7.1% (Chart 6), the highest percentage since early 1994.
These numbers are expected to continue upward through 2009, compounded by the impact of impending job reductions in the regional employment centers (New York City and Philadelphia), which have only begun to soften.
New Jersey Housing Market
The sales of existing houses (“resales”) in New Jersey peaked in 2004, when 188,700 units were sold (Chart 7). Based on data through the third quarter, it appears that the total number of resales in 2008 will be around 115,000 (+/- 5%).
There are several different measures of housing prices, each with known strengths and weaknesses. While each is internally consistent, none provides a comprehensive statewide estimate based on comparable units. Consequently, any estimate of average price changes (including those in Chart 8) should be taken with a grain of salt – preferably a very large grain.
The various data sets are consistent in one conclusion: New Jersey’s housing prices have declined less than the national averages; but rather than testifying to the resilience of prices here, the difference reflects how catastrophic conditions are elsewhere.
My estimate is that, on average, housing prices in New Jersey have declined about 15% from their peak. While substantial, this is far below the national average of 23%.
Similarly, while the proportion of mortgages in New Jersey that are delinquent (Chart 9) has risen to relatively high levels, as has the number of units in foreclosure proceedings (Chart 10), conditions are far less problematic here than in other states.
Although it is not possible to produce a precise estimate, mortgage-related distressed sales are at record levels and are exerting downward pressure on housing prices generally. This will persist well into 2009.
Homebuilding in New Jersey is 52.8% below its cyclic peak in 2005 (Chart 11). This is below the national decline (-58.6%) because New Jersey was not part of the 2003-2006 building frenzy which gripped states such as California, Florida and Arizona.
Multi-family activity has been increasing since the late 1980s. As redevelopment advanced in the State’s older metropolitan areas, the trend accelerated to where multi-family structures now account for over one-half of all housing starts in New Jersey.
There are two additional points to be made regarding New Jersey’s housing:
• The combination of rising incomes, falling housing prices, and declining interest rates has markedly improved housing affordability in the Garden State (Chart 12); and,
• Having avoided the 2003-2006 national building frenzy, the State’s inventory of unsold new homes is relatively small (although pricing remains problematic).
For the past several years, as the housing sector was retrenching, nonresidential real estate (i.e., commercial, industrial, and retail properties) remained relatively buoyant. Occupancy rates remained high, rents were rising, and values were increasing.
That is no longer the case. To a considerable degree, nonresidential’s reversal reflects the persistent turmoil in financial markets and the growing weakness in the general economy. Some of it, however, is due to that sector’s cyclic pattern.
Regardless of causes, the nonresidential sector is now experiencing rising vacancies, softening rents, and declining values. Though not true of all properties, this will become increasingly prevalent as employment declines.
New Jersey Outlook
Although the impact of the national recession on New Jersey was, until recently, somewhat muted, that is no longer the case. Indeed, given retrenchment in key sectors -- financials, retail, business services, etc. – the State’s economy may contract more rapidly in 2009 than the nation as a whole.
My outlook for the State’s economy is summarized in Chart 13. In sum, New Jersey’s GDP is expected to decline sharply over the next six months, with employment continuing downward and real after-tax incomes shrinking.
In the second half of the year, activity will bottom and remain at recessionary levels. But employment will decline further as some firms fail and others reduce payrolls in response to diminished demand.
Despite the bottoming, assuming trend growth in the labor force, by the end of 2009 the unemployment rate will approach (perhaps even surpass) 10%.
Assuming a front-loaded Federal stimulus package, economic activity in New Jersey should begin to pick up early in 2010, but the “recovery” will be tepid.
Charts 14 and 15 summarize my outlook for the real estate sector.
Resale prices will continue downward in the first half of 2009, but much of that will be driven by distressed sales (i.e., foreclosures). Resale prices should begin drifting upward in the third quarter.
If the volume of resales did not bottom in the fourth quarter of 2008, it is in the process of doing so. Resales will remain relatively flat through the spring and then begin to pick up in the summer. In the first quarter of 2010, resale volume should be at an annualized rate of 125,000 – 12-15% above current levels.
The inventory of resales will rise, however, as once discouraged sellers re-list their units.
Building activity will remain depressed throughout 2009. If no more than 14,000 building permits issue in the coming year – as I expect – 2009 will be the weakest year for homebuilding in New Jersey since World War II.
As suggested earlier, the nonresidential sector faces stiff challenges over the next two years as:
• Vacancy rates rise due to declining employment and the completion of buildings now in the pipeline;
• Weakness in the general economy lessens demand for industrial and storage space; and
• Retail sector retrenchment increases store vacancies.
As these factors reduce income and financial constraints (i.e., diminished availability and increased credit costs) reduce capital, property values will decline and private nonresidential construction, which until recently was relatively robust, will slow sharply and remain weak into 2011.
Mr. Chairman, this concludes my statement. Again, thank you for giving me the opportunity to brief you.