by Calculated Risk on 10/28/2005 08:48:00 PM

The Economic Alliance for Business (EDAB) just released their October 2005 East Bay Quarterly Forecast, authored by Christopher Thornberg, Senior Economist for UCLA Anderson Forecast (thanks to Robert Sakai). The report is fairly positive on the economy over the next few quarters, but is cautionary on real estate. Dr. Thornberg writes:

The good news is likely to continue for the next few quarters. Katrina and Rita may have monopolized the newspapers, but they will have little impact positive or negative on the California economy. Gas prices are already on their way back down. Demand is softening as the year moves into the winter season and refining capacity is coming back online. With pockets flush again, expect a solid holiday season for retailers in the area.

But there are storm clouds on the horizon that are being generated by yet another low-pressure system building up -- our housing markets. Prices have continued their truly meteoric rise, as has the pace of building. But there are signs the market is starting to lose its oomph. Market activity in the Bay Area has started to slow sharply, and inventories are on the rise.

From the section on Real Estate: Is the party coming to an end?

As has been discussed in this and past reports, the primary driver of the California economy, including the Bay Area and the East Bay, has been the residential real estate boom. ... All this new construction has been creating many of the new jobs in the state including those in finance companies working to extend credit. And while we lack direct evidence, it appears that consumer spending is being fueled largely by the wealth being generated within the economy by the massive rate of appreciation.

After a discussion of housing fundamentals, Thornberg states:

... housing prices should have basically gone flat as of Q4 2002, and instead they have grown at an unprecedented pace. While there is some room for debate on this issue, I put the starting date of the downturn in ‘per worker income’ at Q4 2002. On this basis, we can guesstimate that property in California is now overvalued by something close to 35 or 40%.(emphasis added)

Thornberg concludes:

The market is still red hot of course. Price appreciation and market activity continue at a record pace. Nevertheless, right now the bubble is clearly starting to lose steam.
...
The best indicator that the party is starting to end will be a decline in overall market activity—slowing of total unit sales and build up of inventories. When inventories rise and sales start to fall this will spill over into price appreciation and construction within three to six quarters, and this is when the overall economy will begin to feel the pinch. Right now the market appears to be at a crossroads. According to the latest numbers available, market inventories in the state have almost doubled over the past six months and overall market activity has been flat albeit at a very high pace.
...
... things are clearly at a tipping point. And remember, while it is unlikely that nominal home prices will fall rapidly, that does not mean a cooling market will do little damage to the economy. A cooling market is characterized by a large drop in new building units, market activity, and refinancing activity, not to mention heightened foreclosure activity. A lot of the new jobs in those areas will suddenly start to disappear. And don’t forget those wealth effects. When consumers realize they can no longer expect that appreciation bonus to subsidize their consumption habits, they will very likely pull back on spending. Keep an eye out.