2001 economic outlook

With a real estate market that keeps going up, where do we go from here?

by Mark Dotzour   If the real estate market in 1998 was red hot and 1999 was white hot, then 2000 was a blast furnace. It takes three components to have a strong real estate market: population growth, job growth, and low mortgage rates. In most parts of Texas, we have been blessed with all three. As of the date this is written, home sales in Texas are up 2% from the banner year in 1999. So, where do we go from here?

People keep coming to Texas, and they all need places to live
First, population growth is inexorable in this state. Every year, our population grows by about 340,000. This trend is almost certain to continue next year.

Inflation looks like it has leveled off
Mortgage rates are likely to remain near current levels for at least the next six months. Mortgage rates are almost exclusively determined by the rate of inflation, which has leveled off at an annual rate of nearly 3.5% in 2000, up from around 2% in 1999.

It would be unlikely to see the inflation rate increase much further in 2001, because the Federal Reserve is using all of its tools to slow down the economy. Six interest-rate increases and a slower rate of growth in the supply of money have succeeded in reducing the rate of job growth in the country and also in Texas.

Texas economy: coming in for a soft landing?
Job growth in the U.S. has slowed from a rate of 3% in January 1998 to a current rate of just below 2%. Texas has experienced similar declines in job growth, falling from 4.5% in January 1998 to 3% recently. The Texas Comptroller’s Office sees employment in the state growing at a rate of 2.1% in 2001. So, the economic engine is slowing, but very gradually. If this scenario plays out, Texas will have its version of the "soft landing" that the Federal Reserve is trying to bring about for the national economy.

Three factors to keep an eye on
Several currents will impact the Texas economy in the new year:

1. Oil and gas exploration drilling in Texas has increased by more than 100% from the lows reached in 1999. The number of wells drilled in October 2000 was 388, up from 188 in April 1999. This increase in activity will have its heaviest positive impact in three areas of the state: El Paso, South Texas, and Northeast Texas.
2. The level of construction activity in Texas is likely to ease. Texas builders have produced almost as many homes in the past five years than in the previous ten years. In 1999, 101,928 building permits were issued for new homes. The year 2000 will likely close at a level of 105,000 units. Low interest rates and new lending programs to encourage first-time buyers will likely fuel demand for homes at current levels. Apartment construction has been waning for the past two years. In 1998, the number of building permits for apartments peaked at 56,918 and declined dramatically to 44,716 in 1999. At the time this article was written, permits in 2000 were down 25% from the lower levels of 1999. Apartment construction is likely to be sluggish in 2001 as the marketplace continues to absorb the new space produced in the past few years.
3. Finally, home sales volume should remain at high levels in 2001. The combination of low interest rates, new mortgage programs to expand the rate of homeownership nationwide, and continued job growth in almost all areas of the state should create an environment that supports a healthy residential sales market.

Could we be facing a recession?
What factors could derail the above scenario? First and foremost, the final results of the "financial engineering" by the Federal Reserve are not certain. It is possible that the six rate hikes could have the unintended consequence of slowing the economy to the point of a recession. While a recession in Texas is not likely, the risk is certainly higher in 2001 than it was last year.

Second, Mexican political elections have traditionally been associated with significant devaluation in the peso. Peso devaluation has significant negative impacts on the border communities in Texas. Most analysts are cautiously optimistic that this will be avoided this year.

Mark Dotzour is chief economist for the Real Estate Center at Texas A&M University.

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