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Unemployment and Residential Real Estate Markets

Published by Lawrence Roberts | December 26th 2008 | Views:

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Prior to the Great Housing Bubble, house price declines had only been associated with economic downturns and increases in unemployment. As people lost jobs, they lost their ability to make house payments, and many lost their homes in foreclosure. Unemployment is devastating to housing markets.

When the economy softens, wage growth slows down as employers are less able to pay higher wages and the competition for available work makes people less able to demand higher wages from their employers. The economic slowdown is thereby responsible for slower rates of house price appreciation. If the downturn is more severe, rising unemployment serves to push prices lower because the unemployed cannot afford to make their house payments, and their houses often fall into foreclosure. As unemployment increases so does the number of foreclosures, and since there are fewer buyers in a recession, the number of foreclosures cannot be absorbed by the market without a lowering of prices to meet diminished buyer demand.

There is evidence that housing market downturns may actually be the cause of many recessions. There is a strong correspondence between the times when the country enters and exits a recession and when the times when residential construction spending drops off and picks up. The recession of 2008 was clearly caused by the problems in the credit markets and the resultant slowdown in consumer spending related to the collapse of house priceo Irvine and Orange County, California in 2007. New Century Financial went bankrupt along with numerous other subprime lenders based in Orange County. Real Estate related employment went from 15% of the workforce to 18% during the bubble. Most of these workers were laid off when the housing market slowed significantly. Many of the realtors and mortgage brokers in Orange County, California, and Irvine in particular, made hundreds of thousands of dollars a year off real estate transactions during the bubble. Most of these workers were not W-2 employees counted in regular government statistics. Transaction volumes declined 80% from the peak in 2005 to the end of 2007 in Orange County. Prices declined 15% as well. This resulted in a decline in income for realtors and mortgage brokers which put many of them in financial difficulty. Also, many if not most of these members of the real estate industry invested heavily in real estate and acquired multiple properties. Faced with the near elimination of their income, an inability to borrow more money and payments far in excess of any potential rental income, many of these individuals financially imploded and let all of their properties go into foreclosure.

One of the largest contributors to the Irvine, California, economy also does not show up in the unemployment statistics: people's houses. Median house prices went up in value an amount equal to or greater than the median household income for 5 consecutive years from 2002-2006. It was as if every homeowner had another breadwinner in the family. With home equity withdrawal, this money could be taken out at any time without IRS withholding. On a cash basis, a family's house was actually contributing more cash to spend than the household wage income. Not everyone took out this money and spent it, but a great many did. When prices fell and credit tightened, the mortgage equity withdrawal spigot was shut off. Imagine the impact on the local economy when half of its "workers" lose their incomes.

With the diminishment of wage income, commission income, and mortgage equity withdrawal, many businesses in Orange County began to suffer. This had ripple effects through the local economy. The lower income began to show up in weakening rents and higher vacancy rates at the major apartment complexes, but the major problem for the housing market was the unemployment. As the unemployment numbers went up, so did the number of foreclosures. As unemployment and foreclosure rates go up, real estate prices go down.
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