Good Information Key to Region?s Success (Market Forecast)

For the past few months I have been referring to what happened to the residential real estate market in Northwest Arkansas as the “perfect storm.” Specifically, the storm resulted from the combination of an extremely competitive banking environment and rapid acceleration of residential development, which at first addressed existing housing shortages in certain price points, but quickly developed into market saturation.

What is notable about the recent history of the real estate market in Northwest Arkansas is that during this process of boom and bust, some people had much better information than others. Most importantly, the lack of widely available consistent, accurate, reliable information is likely to hurt everyone in the market, including those who saw the storm coming.

When I was teaching at the University of Arkansas, my colleagues and I extolled the virtues of the free market. As any principles of microeconomics student can tell you, an important caveat to the successful functioning of competitive markets is the lack of perfect information. Obviously “perfect” information is tough to come by but pretty good information is often sufficient to keep from making major mistakes. Unfortunately, some market participants didn’t realize what they didn’t know until it was too late.

If all of the participants in the real estate market had equal access to good information, many of the current problems might have been avoided.

For example, had all banks been able to simultaneously monitor what was happening with developments they had funded as well as developments that other banks had funded that competed with their own, and what was in the pipeline, the difficulties we see builders and developers having today might have been avoided.

Moreover, the costs of poor information do not simply accrue to banks and the developers and builders they loan money to – they are borne by all of us. It isn’t just that a few banks made bad loans to speculative homebuilders and aggressive sub-dividers which they are now forced to foreclose on or take back. Too many new homes in the market force builders to sell at a discount. This means someone who is trying to sell their existing home must compete with reduced prices for new homes. As banks take back property, they are much less reticent to lower price, meaning even more pressure on homeowners trying to get as much out of the sale of their home as possible.

This is the heart of much of the downside risk to the national economy. As people’s homes were appreciating, rapidly in some markets, they experienced a wealth effect. Increasing wealth does not effect consumption in the same way rising incomes do, but people still increase consumption as they feel wealthier. Given that consumer activity represents approximately two-thirds of Gross Domestic Product, anything that increases consumer spending has a substantial impact on other economic statistics such as job creation. Therefore, it is not surprising that declining wealth associated with declining housing values pose the single greatest risk to the national economy. The Federal Reserve Board of Governors have taken recent steps to shore up the macro-economy, but the depth of problems in the housing market are unlikely to be overcome with a marginal reduction in the discount rate.

The problems with the real estate market in Northwest Arkansas are not nearly as severe as they are in many markets across the U.S., particularly markets on the coasts. In addition, much better market information is currently available. If we examine the data the necessary steps are being taken to correct imbalances in residential markets in Benton and Washington counties. Positive absorption of existing empty housing stock implies that perhaps by second quarter of 2008 we will be able to call the turn in the residential real estate market in Northwest Arkansas. That would be good news for everyone, not just bankers.

(Jeff Collins, Ph.D., is an economist and partner in Fayetteville’s Streetsmart Data Inc. The company produces a quarterly report on all aspects of real estate in Northwest Arkansas. More information may be obtained by calling (479) 872-1000.)