MAKING CENTS -- Ikea-ize the Outside!

July 5, 2012 - 09:12

The economic outlook continues to improve, but there are still some obstacles that need to be addressed.

One of my favorite meetings each year to attend (and speak at) is the Big Grower Executive Summit (BGES) and this year’s meeting in San Diego was no exception. 

Besides the critical information provided by the noted speakers, the information exchange and interaction among the participants is invaluable. I learn as much (or maybe more) from those attending the meeting, as I’m sure the participants learn from me. 

If nothing else, I always learn about a few more books that I need to add to my reading list each year!

In my BGES remarks this year, I focused on the economic outlook and its impacts on the upcoming election. It probably comes as no surprise that I had mostly good news to report. There are several positives pushing the economy forward including improved household finances, moderate employment and income growth, declining inventory of new and existing homes, stock market improvement, and increasing corporate profitability. 

The financial system also continues to heal, supporting this growth, although lenders remain conservative and some businesses and consumers still have only limited access to credit. 

The Flip Side

But there are a few counteracting negatives weighing down the economy including the continued declines in home prices, financial uncertainties abroad, and impending fiscal adjustments that the Fed will likely have to make some time this year. The net effect of these positives and negatives is continued moderate growth in the economy with gradually declining unemployment. The biggest uncertainty, however, is one that most economists are still struggling with at the moment and that is the effect of higher fuel prices and other inflationary pressures on the economy. We know from history that increases in the cost of gasoline and food force at least some temporary adjustments in household budgets. 

The Energy Information Administration (EIA) expects the price of West Texas Intermediate (WTI) crude oil to average about $106 per barrel in 2012, which is $11 per barrel more than the average price last year. The EIA also expects regular-grade motor gasoline retail prices to average $3.79 per gallon in 2012 and $3.72 per gallon in 2013, compared with $3.53 per gallon in 2011. 

During the April through September summer driving season this year, prices are forecast to average about $3.92 per gallon with a peak monthly average price of $3.96 per gallon in May. Geopolitical dynamics in the Middle East (mainly Iran) are driving much of the current speculation in the market which is affecting pricing behavior this spring. We’ll see how that situation ferrets itself out as the year progresses.

The keynote speaker at this year’s Big Grower Executive Summit was Ken Gronbach, author of The Age Curve: How to Profit from the Coming Demographic Storm. You have heard me speak of Ken’s book before but it was a real treat to hear him speak in person of future demographic changes and how they will be impacting our industry in the long term. While there are certainly significant near-term driving forces to contend with Ken was optimistic about the future of our industry, particularly in terms of home improvement sales that are, of course, correlated heavily with housing.

The Housing Market

Speaking of housing, total housing starts are expected to rise by 726,000 units in 2012, up 18 percent from 2011 but still a small fraction of the 2005 peak of more than two million units. The overwhelming majority of those gains will remain concentrated in the multi-family market where real estate investment trusts are funding apartment construction. 

The recovery in the single-family market will remain subdued, with starts hovering slightly above the lowest levels (after adjusting for population) since the Great Depression. Home sales are expected to rise to 5.1 million units in 2012, up 10.7 percent from 2011. The majority of those gains will be in the existing home market, where buyers can get a better bang for their dollar on upgrades and investors can convert foreclosures into rentals.

The factors driving the demand for housing are expected to continue to improve, however, over the course of 2012. Income growth is expected to pick up with a more substantive (albeit still subpar) recovery in employment. 

Inflation-adjusted home prices have overshot on the downside and mortgage rates have plummeted, pushing housing affordability to record highs. The pent-up demand for housing is mounting as the number of would-be buyers waiting on the sidelines continues to rise, while household formation is picking up. The recent increase in employment should help to unwind some of the doubling-up that occurred in the wake of the recession. Consumer sentiment has moved off of the lows that we saw last year and appears to be trending up again, with much of the improvement occurring in expectations. Optimism about job creation, in particular, soared in February, which could prompt some buyers to move off of the fence and buy. 

To Be Determined

That being said, the headwinds facing the housing market remain significant. The distribution of income gains remains extremely uneven, with many of those who have lost a job accepting lower pay and less job security than they had prior to the recession. This, coupled with falling median incomes, is excluding a larger percentage of the population from qualifying for a mortgage. 

Banks remain cautious about underwriting mortgages, as the secondary market for mortgage-backed securities remains all but crippled. Fiscal policy uncertainty could cause another crisis in confidence and push up long-term interest rates, as Congress grapples with the scheduled expiration of the Bush-era tax cuts, mandated spending cuts and another debt ceiling fight. 

The result is a housing market that continues to recover, but remains subdued relative to historic norms. Investors, cash buyers, and first time buyers (who don’t need to sell a home to buy) will continue to dominate the market. Apartments are attracting the most attention from investors, but there is also a pickup in activity by smaller investors in the single-family and condo markets. Condos are easier for small landlords to convert into rental properties, as long as the condo association allows rentals. 

The bottom line is that the housing market is finally beginning to show signs of life after being nearly dormant for much of the recovery. We are still battling a chronic illness, however, which will lead to additional overshooting on the downside. It will take well into 2014 for the housing recovery to resemble anything that could be considered normal. Even then, renters will play a much larger role in the market. Hence, the Fed’s expectation that interest rates will remain low until late 2014.

As evidence that investors are starting to take note of the housing market again, the folks who run Ikea, the Swedish home-furnishings behemoth, are launching a bold push into the business of designing, building and operating entire urban neighborhoods. Where once they placed a couch in a living room, the Swedish retailer now wants to place you and 6,000 neighbors into a neglected corner of your city, design an entire urban world around you, and Ikea-ize your lives. 

Their bold, high-concept notion of an urban ’hood could be an important solution to the housing-supply shortages that plague many large cities -— but an all-rental private neighborhood that is run and overseen by a private company could take some getting used to. 

Personally, I don’t mind if they Ikea-ize the inside and long as they don’t forget to plant-icize the outside!

About The Author

Charlie Hall is Ellison Chair in International Floriculture in Texas A&M University’s department of horticulture. He can be reached at c-hall@tamu.edu.

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