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Thursday, May 17, 2012
Feature: April 2006
Keeping the Faith
Our economic experts discuss the still-promising Sacramento market
Story by moderator Sanjay Varshney
When our financial roundtable convened last year, the real estate sector looked great. How quickly times have changed. But the local real estate slowdown makes sense — real estate as an asset class has never really outperformed stocks over long horizons.
Though Sacramento is cooling off, many are still bullish about Sacramento relative to other California markets that appear to be more vulnerable. Sanjay Varshney, dean of Sacramento State’s business school, recently picked the brains of local financial experts Brent Cardwell, Dan Bienvenue and John Dutton to find out where our economy is headed.
Varshney: Gentlemen — welcome! Let’s see what you have to say. Where is Sacramento’s international population coming from, and why are they migrating?
Cardwell: The Sacramento region has had the fastest-growing population in the state over the last five years and is projected to remain the leader through the end of the decade. The majority of the growth has been domestic and can be attributed to the influx from the Bay Area and Southern California.
Migration from other countries is expected to represent a larger piece of total migration for the region. Migration from Mexico has represented the majority of international migration over the last 10 years, but migration from other countries such as Asia, India and the Middle East is expected to accelerate.
What makes this region attractive to people across the world? In my opinion, the combination of wealth and mobility in developing countries and relative affordability within the state lie at the root of this trend, which I expect to continue.
Bienvenue: Sacramento is a very desirable place to live, and that is attracting population growth across the spectrum. The region has both blue- and white-collar job growth, which, coupled with affordable housing, makes it attractive. This migration has created a melting pot in the Sacramento area.
Dutton: Today, less than half of the state’s population is white; the majority is made up mostly of Latinos, but with sizable proportions of Asians, African-Americans and multiracial Californians. Almost half of all births today are to Latina mothers. Latinos are now the largest ethnic group of state residents under age 30. They are expected to become the largest group in the state within a decade, and eventually will account for half of the state’s population.
I expect Sacramento to mirror the rest of California, with Latinos being the largest group, then Asians, then Slavic immigrants from the former USSR and Yugoslavia.
Dr. Sanjay Varshney, CFA, is dean of the College of Business Administration at Sacramento State. He is also a private money manager.
John Dutton is a 35-year Wall Street veteran and is CEO and president of JM Dutton & Associates, one of the largest independent investment-research firms in the United States.
Brent Cardwell, CFA, is senior investment manager and vice president for Wells Fargo Private Client Services.
Varshney: Why are median home prices in California higher than they are in any other state?
Cardwell: Simply stated: lack of land, an aging U.S. population with growing wealth, and climbing global wealth, which is feeding international migration and thus housing demand. Or, put in numbers, migration to California exceeds the number of new housing permits.
Combine this phenomenon with superior affordability relative to the Bay Area and Southern California and we can see why the Sacramento region’s housing market has been robust.
Dutton: Throughout much of California, housing production has fallen behind the rate of population increase, a factor that contributes to high purchase prices and rents. Income levels combined with more leveraged purchase financing contribute significantly.
Bienvenue: California is a desirable place to live, period. I’m sure that all of us have, at one point in time or another, complained about the cost of living in California, and yet none of us leave.
Even the less desirable places in California — I won’t name names — seem pretty nice relative to places like Nebraska and Minnesota. The weather is good, the population is generally educated and modern, there is a great deal of natural beauty (just think of the number of national parks in California as a percentage of the total number in the country), and the infrastructure is good. When demand is high for even the low end of the market, everything appreciates, which lends itself to a high median home price.
Varshney: Why was the Sacramento region so undervalued relative to the rest of California in 1998 and 1999?
Cardwell: The mid-’90s recession hit the Sacramento region — and the Los Angeles region — hard, especially real estate values. Later, the Bay Area tech revolution and Southern California’s recovery dominated state economic growth.
Still, between the mid-’90s and 2004, the Sacramento region experienced significant population and employment growth. This was overshadowed by the explosive migration of jobs and capital to the Bay Area. Of course, since the bursting of the tech bubble, the reverse is occurring: Population, jobs and wealth are leaving the Bay Area and heading to the Sacramento and San Joaquin regions.
Today, the Bay Area economy is in the midst of a major transition that will take several years to play itself out, in my opinion. One element of this transition is the realignment between income and lifestyle (i.e. affordability). A main driver behind the robust population, income and employment expectations for the Sacramento region is the continuing transfer of Bay Area jobs and wealth to Sacramento.
Dutton: People started moving here as the dot-com boom ended and it got too expensive in the Bay Area. Intel and Hewlett are moving plants to this area due to its cheaper cost of living.
Bienvenue: I’m not sure I can say that Sacramento was so undervalued in 1998-99, just that some people figured out earlier than others how great a place it is to live. I think that over time, as people became increasingly frustrated with the quality of life in places like Los Angeles and the Bay Area, the word gradually got out, which has driven up home prices.
Varshney: The Federal Reserve has raised rates 15 times and counting, and the Arms Index is inching up. What impact will this likely have on our region?
Bienvenue: Supply finally seems to be catching up with demand; this should moderate home prices a bit. Given ongoing demand due to the migration discussed earlier, I certainly don’t envision a significant correction in the real estate market, just a bit of a breather as the market adjusts to higher rates.
Dutton: We see a leveling of growth rates and increased discretion in consumer spending due to slowing new-housing construction and an increased inventory of unsold existing homes.
Cardwell: It’s clear we are nearing the end of this tightening cycle. We may well be down to the final or final two 25
basis-point increases in 2006.
Actually, because rate increases have had the desired effect of keeping inflation tame, the national, state and Sacramento economies have benefited. Rising to flat employment, incomes and home equity as well as abundant liquidity have negated the short-term effects of increased short-term borrowing costs.
It’s true that housing appreciation has slowed recently, but I believe that influences such as price compression and homeownership saturation — more people own a home than ever before — are the major culprits behind the waning pace of real estate prices. Liquidity has been, and will continue to be, plentiful.
Varshney: What industries are moving or are likely to move into Sacramento, and why?
Bienvenue: I think that the two main industries we’ll see moving into the area will be technology and finance. Technology has been coming in for some time now, and I don’t see that changing. Due to Sacramento’s proximity to Silicon Valley, a supply of educated individuals graduating from our local colleges and universities, and the relatively reasonable cost of living, technology companies will continue to realize the benefit of having a presence in the region.
As this continues — along with the rise of many other successful industries in the region, such as real estate development, agriculture and entertainment — wealth in Sacramento will continue to accumulate. The accumulation of wealth coupled with the same pro-business reasons that are drawing technology companies will spur growth in the region’s finance industry.
Cardwell: I believe the Sacramento region will continue to attract small to midsize manufacturing companies and large commercial and retail-services companies. Basically, with job and population growth expected to lead all state regions, the companies that will service this expansion will follow. I expect existing large tech-manufacturing companies such as HP and Intel to continue restructuring their operations overseas.
Dutton: We also see the region becoming increasingly based on technology and high-end services.
Varshney: How will global economics and labor markets influence Sacramento employment?
Cardwell: The companion to the growing integration of global capital markets is increased mobility for global labor. Improved economic prospects overseas mean more opportunities for international labor to pursue jobs and differing political, cultural and lifestyle settings in more countries.
Much attention has been focused on the outsourcing of domestic jobs overseas, but what is missing in this analysis is the other side of the equation: jobs coming to the U.S. from overseas. For the Sacramento region, the accelerating trend of labor migration from Mexico has been enhanced by additional migration from Asia, India and the Middle East.
Dutton: I see a gradual shift toward a service-based economy here, in the rest of California and in the nation.
Bienvenue: Global outsourcing is a trend that is nowhere near over. Companies will continue to outsource jobs to lower-cost production facilities on a global basis, which means easily transportable items with low capital and productivity requirements for production, such as textiles and consumer durables, will be produced overseas with lower overhead costs. Less-transportable items and more capital- and technology-intensive industries — perishables, research and development, etc. — will drive the local economy.
Varshney: If the construction industry declines, what impact will that have on Sacramento employment?
Dutton: I expect some decline would be healthy — it really goes a long way to stabilize prices. Too much of the decline, however, would affect the wealth of the region’s residents, whose spending habits would be moderated.
Bienvenue: Much of Sacramento’s workforce is employed by the construction industry, so a decline in the industry will have negative consequences on employment. That said, I think one can make the argument that the industry has been operating at greater-than-full employment for a while now — who among us doesn’t have or know someone who has a horror story about dealing with a construction project?
Absent a sudden and steep crash in the industry, which I don’t envision, gradual changes will be adjusted to gradually and the job market will hang in just fine.
Cardwell: When the construction industry declines, it will occur during a general economic decline, or recession. In this context, the question can be rephrased to address any extraordinary economic effects that may strike the Sacramento region, which is becoming more and more driven by housing.
The local construction-industry labor pool is characterized by its unique skill sets. During recessions, labor pools with diverse skill sets fare better because workers can simply move from one industry to another. Regional economies with highly concentrated and specialized skill sets are more vulnerable to prolonged economic downturns.
A good example is the Bay Area, where, when the tech bubble burst, unemployed specialized labor had to leave the region to find employment. This exacerbated the recession there by reducing the economic stimulus of income.
Regions with diverse labor pools tend to be more resilient to economic downturns because more skills are transferable from one industry to the next. This means that while unemployment may grow, the economic problem is not compounded by labor leaving the region.
Varshney: Thank you, gentlemen.
