Office of External Communications

Houston, TX 77204-5017 Fax: 713.743.8199

FOR IMMEDIATE RELEASE
May 5, 2005

Contact: Angie Joe
713.743.8153 (office)
713.617.7138 (pager)
ajoe@uh.edu

HOUSTON, May 5, 2005 – The latest revisions of regional employment data portray a local economy that remains much weaker than previously indicated by the Bureau of Labor Statistics. While some of the revisions do not make much sense, the bottom line is that the local recovery remains almost exclusively attributable to growth in oil and gas exploration and very little else, said Barton Smith, University of Houston economics professor.

During his annual real estate symposium, Smith indicated that there are recent signs that the regional growth rate is creeping upward, but not at the pace previously anticipated and certainly not at the pace most would have expected with $50 per barrel oil prices.

The UH director of the Institute for Regional Forecasting addressed more than 1,000 people at the Hyatt Regency Downtown at his real estate-focused program, “The Impact of Rising Interest Rates on Houston’s Economy and Real Estate Markets.” As that title suggests, Smith spent much of his presentation discussing how high interest rates are likely to go during the next 12 months and what that might mean to area real estate values.

“It is hard to predict right now what the Federal Reserve Bank will actually do in raising rates, but I believe the most likely scenario is that it will increase rates to more normal levels in two phases,” Smith said. “The first phase will likely end this summer and the second phase will not likely begin until 2007. Unlike 1995, when the ‘Fed’ dramatically pushed rates upward, the ‘Fed’ faces the predicament that the nation’s housing market is extremely vulnerable to sharply higher rates. Any rate move that is too harsh and too fast will bring the inflated housing markets in the West and East down with a crash. I think they will try to orchestrate a ‘soft landing’ for the nation’s housing market this time, but it will prove to be significantly more difficult than simply cooling down the national economy somewhat, as they did in 1995. It will be a miracle if the ‘Fed’ can fine-tune rates just right to keep inflation in check without bringing many of the nation’s hyperinflated housing markets crashing down.”

While Houston’s housing market is nowhere near being overinflated, Smith said, it is currently suffering from oversupply. This oversupply is not to the extent of the mid-1980s, but sufficient to end home value appreciation and to drive foreclosure rates up. Furthermore, if the nation’s housing market takes a tumble, it will affect Houston indirectly through its effect on the U.S. economy. Falling home values in about two-thirds of the nation will reduce consumer wealth and hence spending. That, in turn, will slow the national economy, which in turn will slow Houston’s economy. High energy prices alone are just not enough to create a booming economy in Houston anymore, Smith reminded his audience.

Upstream energy grew at nearly 5 percent last year, yet the overall economy grew only 0.9 percent. Houston will do better next year, Smith predicted, but downstream energy, including refining and petrochemicals, have been lost as a source of growth and non-energy growth is coming back to life ever so slowly.

“I expect job growth in 2005 to be twice that of last year and 2006 will be better, but neither year will come close to the boom-type of growth the region experienced in 1997-98 when all engines of the economy were at full throttle,” he said. “The primary question mark is when will the ‘housing market correction’ hit the nation with full force. If it occurs as predicted in 2007, then we still will have a couple of good years left to the recovery before we hit rough seas.”

Houston ought to weather that storm better than most, Smith pointed out, but the city won’t be immune to the impact, especially if the ‘Fed’ is not careful and lets things get out of hand as they did with the stock market correction at the beginning of this decade.

Other types of real estate will be less vulnerable to rising rates, but will struggle for several years with the burdens of excess supply. Rising interest rates will actually help the beleaguered apartment market as they eventually stem the flow of households from the rental to the owner market. Nonetheless, Smith warned that the worst is yet to come for this market as new supply has still failed to respond to the realities of the excesses being built up. It appears that this market will take the rest of the decade to eliminate all of the excesses. Only if new supply were to totally end might this market have a chance to return to normal within three or four years, but he doesn’t expect that to happen.

“Houston’s other commercial real estate markets look to be in better shape,” he said. “They simply need the region’s employment growth rate to rise.”

The office market, which received the most negative press over the past couple of years, has seen a significant decrease in new supply and the beginnings of positive absorption. This will help it get back to normal much more rapidly than the apartment market. If Houston generates between 35,000 to 45,000 new jobs per year during the rest of this decade, constrained levels of construction should allow office, retail and industrial vacancy rates to return to typical levels within three to four years.

Whether the recovery in these real estate markets will be complete by then depends upon how severe the national housing market correction is and how much of an impact that correction will have on the national economy, which, in turn, spills over to Houston’s economy. The housing market correction of 1989-91 produced a national recession. If that occurs, Houston will feel it, Smith said, even though the city’s housing market represents one of the best bargains in the country. The average price per square foot of housing in Houston is only $79 per square foot. That compares with a national average of almost $120 and with prices in the west and along the east coast ranging from lows near $175 per square foot to highs in excess of $500 per square foot.

Smith has conducted numerous studies in urban issues, housing, transportation and the environment. During the past 15 years, he has gained national recognition for his analyses of the Houston economy and real estate markets. Smith wrote “Handbook on the Houston Economy” and continues to publish two symposium reports a year on Houston’s economy and real estate markets.

About the University of Houston
The University of Houston, Texas’ premier metropolitan research and teaching institution, is home to more than 40 research centers and institutes and sponsors more than 300 partnerships with corporate, civic and governmental entities. UH, the most diverse research university in the country, stands at the forefront of education, research and service with more than 35,000 students.

For more information about UH visit the university’s ‘Newsroom’ at www.uh.edu/admin/media/newsroom.