Nobody’s Home: Real Estate Markets in Declining Cities
An Interview with James Follain
Q: Your paper, A Study of Real Estate Markets in Declining Cities, sought to answer three questions. Can you briefly tell us what they were?
A: The first one was: What happens to real estate markets in cities going through steep and dramatic economic decline?
The second one explored whether some areas or neighborhoods get hit more than others.
Q: In the same metropolitan area?
A: In the same metropolitan area.
And the third one is the toughest, I think: Can we be confident in predicting which of these neighborhoods are hit the hardest? We find some evidence of extreme events within these declining cities and neighborhoods that really get hit particularly hard. It’d be nice to be able to predict which ones they are. But that’s very difficult. So I write about the difficulty about making that kind of prediction.
Q: Let’s start with the first question. What happens to real estate values in declining cities? What were your key conclusions?
A: Here, I think the conclusions are pretty robust. Living in upstate New York, we have some examples of these traditional declining cities where they lose a lot of population and lose a lot of employment. In those situations, you can expect house prices to decline substantially and for a long period of time. And it makes sense: the intuition is people move more easily than real estate. The housing stays, people leave, and that leads to excess supply and prices that plummet.
The trickier part, though, is looking at some of the cities that have been really hard hit by this recession. I think a new type of declining city might be emerging. So it’s not that they’re losing population and employment. But they’re still experiencing a tremendous reduction in the demand for housing, relative to what happened in the early 2000s.
Q: So you’re still getting that discrepancy in supply and demand, even though people are not leaving the area and are not losing jobs at a great rate.
Q: So what does that have to do with? Overbuilding?
A: We built more housing than I think we’re going to be able to demand for some of these places for a long period of time.
Q: The second question concerned the range of variation within a metropolitan area. What did you learn about that?
A: I read a lot, first of all, including case studies of neighborhoods that were really hard hit. What I tried to do, also, was look at seven large metro areas. Some of them are the traditional declining cities; some are the new ones. I looked at vacancy rates, in particular at the census tract level, and you can see some neighborhoods with extremely high vacancy rates that make you wonder how viable they will be, going forward.
Q: So, by vacancy rates — you’re talking about homes and dwellings that have actually been abandoned? Or it’s strictly an issue of nobody living in them at the moment?
A: There’s actually a new survey — we worked with the U.S. Postal Service data — that allows you to make some comments about the duration of the vacancy. In a traditional census, if someone is occupying the unit at the time of the survey, it is occupied; if not, then it is deemed a vacant unit. But what we learned from new Postal Service data is that some units — both business and residential — are vacant for months and months and months. So measurement of the vacancy rate is not just a one-time deal, it’s important to take account of the duration of the vacancy as well. And I found that really enlightening.
And I also tried to build models to predict which neighborhoods were likely to decline — very, very hard, outside the scope of this study.
Q: And that’s the answer to your third question.
I took a deep dive in two places: Cleveland and Stockton. One is a classic, traditional city and the other is a new or emerging type of declining city. I had some unique data that allowed me to identify wide variations around the average outcomes in both places.
Cleveland is a classic type of traditional declining city. Its decline has been going on for years and years and years. I talk a little bit about the history — the last 40 years or so. But I really also wanted to look at what happened in Cleveland in this particular recession. Subprime lending did take place in Cleveland, and we have seen house price declines and increasing foreclosures in Cleveland during the Great Recession. But its economy had troubles long before the Great Recession.
Stockton — I used to live in Sacramento, right up the road, a wonderful, sunny part of the world. But it’s like the epicenter of this housing crisis, it blew the socks off of anything that went on in Cleveland.
Q: Tell us what led to that happening in Stockton.
A: I put a major emphasis in the paper upon documenting what happened to house prices, vacancy rates and types of house sales in the past few years. Though the complete story is complex and still unwinding, my sense is that the key problems were its tremendous emphasis on housing during the early and mid-2000s and inflated expectations about housing demand and house prices in the future. Some of this stemmed from the fact that parts of Stockton are very distant suburbs of the San Francisco Bay area and housing in these areas is relatively cheap. I think its economy was also dependent upon relatively cheap gas prices for commuting and a belief that future population growth was likely to be substantial. This helped fuel a substantial economy built upon the construction and real estate industries. Many of these assumptions are being seriously questioned, which leads me to believe that it is going to be very difficult for Stockton to sustain its current supply of housing. As such, I would expect actual housing demand in the next 10 to 20 years to be below its current supply and, as a result, house prices will remain well below their recent peaks for many years to come.
One thing that really blew me away was the number of house sales. Normally we have what we call “arm’s length” or regular sales, where buyers find a seller …
Q: … often through a broker or real estate agent.
A: Yeah. And so in the early 2000s, in Stockton, 99 percent of the sales were regular. In 2008-09, that went down to about 20 percent. The rest were foreclosure sales, real-estate owned sales (where the banks sell off nonperforming assets) — it was just unprecedented and widespread. We looked at the ZIP code level information for some of this.
Q: So you’re looking at a region within Stockton according to ZIP code.
A: Yes, though we also had access to census tract information about vacancy rates. I found the results just stunning. For example, house prices are now about where they were in 2000, on average. Yet they’ve fallen by over 75 percent in some of these ZIP code areas — even more in some of the smaller areas — since their peaks in early 2006. I find this unprecedented. I do a lot of work on house-price stress tests. And what’s happening in Stockton — in terms of what is an extreme house decline — just blew away anything that I have seen prior to the Great Recession in major metropolitan areas.
Q: When you talk about the ranges that you see within a declining city, did you see a wide range in Stockton, for instance?
Q: Did you see areas that were not suffering this type of decline, and were they defined by their geography?
A: There weren’t any that were not touched. But I have a couple of examples from the paper. One of the ZIP codes doubled in value between 2000 and 2005 — it’s declined now below where it was in 2000. One increased by 115 percent between 2000 and 2005, and it’s only gone back about 10 percent — in other words, it more than doubled, but it’s only declined 10 percent; it’s still well above its 2000 level. You see those kind of variations. It’s striking.
Q: Is there anything that you can say about those variations? Is there any pattern to them?
A: There is a lot of talk about which areas of big metropolitan areas benefited the most from the subprime revolution. In a previous article by my wife, Barbara Follain, and me, we looked at L.A. County, from 2000 to 2006. We broke it down by income in the 2000 census. Which ZIP code in L.A. County do you think had the lowest rate of appreciation during that period?
Q: I only know one ZIP code there — 90210.
A: That’s right. Beverly Hills. Amazing result.
My sense is that the wealthier neighborhoods such as 90210 may also be the ones that are less hard hit by the current crisis. On the other hand, some of the low- and moderate-income neighborhoods, which really benefitted from the subprime lending boom of the early 2000s, may be particularly hard hit in this recession.
Q: We touched on your third question, without fully discussing it. You were looking for ways to predict which neighborhoods are more likely to suffer serious declines. It seems intuitively that would be easy enough to predict if you visited a city. But according to your research it was not, so much. Can you talk about that?
A: Part of what I mean is really predicting extreme outcomes — determining almost a tipping point where a neighborhood becomes no longer viable. I’m really interested in this question of predicting something like that — when is a neighborhood no longer viable?
So you’re really talking about extreme events where you don’t have much information. Think about the oil spill in Louisiana, it’s a very unusual story. Or Hurricane Katrina in New Orleans — those are really hard to predict. And it’s especially hard because we don’t have the kind of data you need to estimate these kinds of models. We have a lot of case studies. But what you really want is nice time-series information for a lot of neighborhoods — 10, 20 years that include a lot of extreme events. We just don’t have data like that.
Q: What do you mean precisely when you say a neighborhood is no longer viable?
A: I don’t have a precise definition of viable, that’s a hard issue because there are so many possible dimensions of a thriving neighborhood. I focused on vacancy-rate measures. Areas with very high and enduring vacancy rates seem at risk. If no one’s living there, then maybe there’s a reason to be skeptical about its future.
Q: What do you see as the outlook for real estate markets in declining cities, based on this research?
A: One part of the forecast is: What do you think generally about housing? And my guess is it’s going to be relatively long-term before we fully recover, for a variety of reasons I talk about in the paper.
There’s some places where I think room for optimism is very weak. One very prominent economist said that Stockton may not recover until 2030. That’s a long time. I suspect there’s going to be a number of places like that, that’ve been hit so hard.
Also I’m quite convinced that regardless of how long it takes for the average price to get up to where it was in 2005 or so, there are going to be some areas or neighborhoods in these areas in which recovery may be very long in coming or never come about.
Q: You joined the Institute in October. Are you planning to build on this research, or do you have other projects in the works?
A: I think this Great Recession that we’re in is just having huge effects and will continue to. I think it’s interesting to get more granular, not to look at the national average, but to look at what’s happening in neighborhoods. I think the data allow us to do that.
One topic that we’re looking at is the impact of the Great Recession on property taxes. Lower house prices reduce the tax base, but the tax base is also affected by lower income taxes and lower sales taxes. My guess is you’re going to see some neighborhoods, even in New York State, that are going to be hit pretty hard — though it’s not going to be hit the same way as Stockton, for example. There are some areas downstate that do have foreclosures in substantial numbers. We’d like to see where they are and what kind of effect they are having, for example, on property taxes.
This is an important period in history. I feel fortunate to be able to be part of this. There’s a claim that economists tend to overstate our understanding of extreme events. That’s a good point. I think you’re going to see a lot more attention paid to our ability to predict extreme events and be prepared for them. I think that’s terrific, and I’m delighted to be part of that.