Friday, October 13, 2017

Is Bend, Oregon in a Bubble?

I grew up in Bend, Oregon and hope to retire there someday soon.  I love everything Bend has to offer (if you don't know Bend, think Boulder or Sun Valley...but better).  I have family, friends, and rental properties in Bend.  So when a friend sent me a video (HERE) with an economist (Bill Valentine) explaining why Bend was not in "a bubble" in mid-2017 and that residential property "prices were virtually permanently headed higher", I was pleased but simultaneously more than a little curious.

My curiosity stemmed from the fact that since 1985, Bend's property values have risen in excess of 6x's.  Since 2000, prices are up nearly 3 fold.  Subsequent to the financial crisis lows, property values have nearly doubled and prices are now marginally higher than the '07 peak.  The same peak which economists unanimously agreed was an unsustainable speculative "bubble".  But this time is different???

To define our terms, "a bubble" is trade in an asset that strongly exceeds the asset's intrinsic value.  Mr. Valentine explained that Bend's property values are not in "a bubble" and that "property prices (in Bend) are virtually permanently headed higher" because "more people want to and can move into Bend from cities with loftier property values than the future supply of homes (in Bend) can keep up with".  So, Mr. Valentine's bet on Bend (or most highly desirable getaway destinations) is a bet on continual property value rises in the larger cities (alongside continued financial asset appreciation...whose ownership is concentrated in the cities).  This will allow these "city folk" to ultimately sell high and buy high in relatively cheaper Bend.  Plus Bend will be unable or geographically constrained from adding adequate supply of new housing to keep up with demand.

Growth Explained...and Why Organic Growth Has Slowed
Growth among the working age population is the key to increasing demand and economic growth.  The chart below shows average household incomes and expenditures (consumption) by age of the head of the households.  Not surprisingly, the 35 to 64 year old population has significantly higher incomes and spends significantly more than young adults or elderly.  In particular, the 45 to 54 year old average household earn more than 2.5x's the income and spend nearly 2x's as much than that of 75+ year old households.  Population growth in the right age segments is critical to economic growth...while growth primarily or solely among the elderly leads to "sub-par" economic growth.
For more than a half century, there has essentially been no growth among the quantity of young in America versus a fast growing quantity of elderly (chart below) and this is the nexus of America's economic, financial, and (probably) political problems.  Despite a much larger total population, total annual births have not grown since 1960 and are currently well below the late 1950's levels.  What has grown is the number of American's living far longer.  What was a 2 to 1 ratio of young vs. elderly in 1950 has been flipped to 1 youth to 1.5 elderly ratio.  But that is nothing compared to what the Census estimates will happen between now and 2050 as growth among the lowest earners and spenders (elderly) swamps the young (0-4yr/old est. is based on average of unrealistically elevated medium and low Census estimates).

The growth of the core (year over year change in 25-54yr/olds) has been the driving force behind America's rise, peak, and deceleration of economic activity since WWII.  In the chart below, the blue shaded area is the annual change in 25-54yr/olds peaking in the late '80's and turning negative in 2008..and again in 2017.  The black shaded area is the annual change in full time employees.  The yellow line is the Federal Funds interest rate (primarily following the change in core population, only intermittently jogging with the business cycle).  The red line is federal debt rising as core growth and interest rates waned.  Plainly, the 2008 housing crisis was (and still is) a population / demographic crisis.
To round out the national picture; growth among the childbearing lot is likely to turn negative or at best continue to grow weakly.  The dashed lines in the chart below represent the Census medium and low estimates for the US child bearing population....and the reality will be somewhere between the two.  Either way, record low birth rates and a collapse in illegal immigration mean that growth among the young has stalled or is set to turn negative while the quantity of those past child bearing age will continue to surge (chart below, data from Census).

The Far West:
Over the past six years, the Pacific states (from which most of Bend's growth comes) has seen the "young" (under 65 year old population) grow by 1.3 million while the "elderly" (over 65 year old population) grew by 1.6 million (chart below).  Although growth of "elderly" is outpacing growth of "young", the West has the best dynamics (save for Texas).  Notably, the Midwest, Northeast, large parts of the Intermountain West, and Southeast are facing significant outright depopulation of their "young" versus surging increases in their "elderly".

The Pacific states growth breakdown, by age groups, from 2010 through 2016 is charted below...clearly California is the driver but Washington has the most balance between the growth of young and old.

But population growth is highly variable dependent on location.  Although national fertility rates are at record lows (and no higher in the cities), immigration plus domestic migration of young adults to these metropolis' is driving higher growth and demand in these cities than elsewhere.  Los Angeles, San Francisco, San Diego, Seattle, and Portland on average are adding 1.2 younger persons for every elderly person added.  Inversely, the rest of the states are adding nearly 2.4 elderly for every young person added.  The chart below breaks out the growth in the combined metro areas vs. combined states (excluding the metro areas), by "young" vs. "elderly" from 2010 through 2016.

However, these metropolis' are running into their own problems of congestion, livability, and rent spirals (to name but a few) which will be drags on further growth.  And going forward, even among the cities the shifting growth in the quantity of elderly vs. decelerating growth among young means sellers are bound to outnumber buyers.

Jobs Growth
Jobs growth in the Pacific states has been among the highest and most consistent over the past three economic cycles (chart below).  Although jobs growth has been cyclically decelerating, down almost 20% from the peak period of job creation, the net job creation in the far West has been a relative outperformer.

Over the last three economic cycles, jobs growth has remained relatively consistent among the major metropolitan Western cities while jobs growth among the remainder of CA/WA/OR have fallen 50% (chart below).  An aside; I'm pretty sure if I added the likes of Spokane, Sacramento, Fresno, etc. that I would find all net jobs growth is taking place in the top 15 or 20 cities and jobs are actually declining across the rest of the West.

And it is these largest of cities that Bend is entirely reliant upon for its continued property appreciation.  So goes LA or San Jose or goes Bend.  To that point, the chart below is the Case Schiller property value index for Portland, Seattle, San Francisco, Los Angeles.  So far, so good for Mr. Valentine's theory as all cities but Los Angeles have made new record high property valuations.
Property values of select West coast cities, in dollars (charted below).  Compared to the major Western metro areas (except Portland), Bend is significantly cheaper on a relative basis.

Simply put, the population growth, demographics of that growth, and economic growth of the far West is the best...but all that positive activity is almost entirely confined to the largest of cities.

Bend, Portland, & Oregon
Let's review Bend, Portland, and the larger Oregon population growth (and demographics among the population change), jobs growth, housing supply, and housing values.

Bend and Portland property values have seen two clear price spikes since 1985 (chart below).  The sharp rises in valuation from '04 through '07 and '12 through '17 are pretty hard to miss.

Below, Bend versus Portland property prices (in $'s).

Below, two variables are offered to describe what is driving the housing appreciation.  The first chart below shows real median household income (adjusted for inflation) that hasn't budged since '00 while home prices have tripled (this lack of income growth is true nationally, as well).  I think we can rule out rising income as the basis of rising property values.

Next, 30yr fixed mortgage rates have fallen 80% since 1981 and 53% since 2000 (chart below).  This interest rate decrease (along with interest only, balloon payment options, etc.) has liberated the money that would have gone to interest on the loan to be redirected into pushing purchase prices higher (of course this is also true nationally, not just in Oregon).

Given real median household income continues to stall and further decline in the 30yr mortgage rate is unlikely (given the Fed is raising interest rates), additional "organic" appreciation of property values (aside from rising populations) seems dubious.  Essentially, the appreciating tailwinds have ceased and a possible or probable rise in mortgage rates will be the start of a growing headwind against further property value appreciation.

Oregon population:
  • Oregon's population rose by approx. 260k, 2010 through 2016
    • 75k were natural increase (births in excess of deaths)
    • 185k migrated to the state (domestic migrants +145k and international migrants +39k)
  • Bend = 4% of state's population & 9% of state's population growth (2010 through 2016)
  • Portland = 44% of state's population & 56% of state's population growth
  • Oregon (excluding PDX/Bend) = 52% of state's population & 35% of state's population growth
Population Change:
Portland's population is growing fast but it is the composition of that growth that is really pushing Portland's economy.  Growth among PDX's "young" earners/spenders is growing in excess of "elderly", primarily on fixed incomes with fixed spending.  This is somewhat true for Bend as well but the remainder of the state has no resemblance to Portland or Bend.  The chart below shows growth per location, further broken down by growth of "young" and "elderly".  Economic vitality and job growth are dependent upon growth among the "young".
Jobs Growth:
Over the past three economic cycles, (from peak to peak) net job growth has decelerated in all regions.  However, Bend and Portland have fared far better than the remainder of the state (chart below):
  • Oregon (x-PDX / Bend) created just 13% of jobs created during the previous peak cycle
  • Portland has created 61% of jobs created during previous peak cycle
  • Bend has created 38% of jobs created during the previous peak cycle

Jobs growth (net) in Bend during this current cycle is less than half the previous two cycles while a lesser deceleration has been seen in Portland.  However, job growth among the rest of the state (the majority population) has essentially ceased.

Property Values vs. Rental Prices
Bend rental prices have likewise risen alongside property values (charted below).  This is really problematic as a near doubling of property values since 2011 has seen a 60% increase in rental prices over the same period.  However, real median incomes (inflation adjusted) in Oregon have actually decreased since 2000.  The decline in real income among renters is surely significantly worse, meaning the 60% increase in rents is eating a significantly larger portion of renters disposable income.  The inability of renters to pay more in rents (absent significant increases in real income) versus the continuing rise in property values should be a red flag for continued property value increases among the lower and middle end single family housing and multi-family segments.  This red flag is not just true for Bend but across the entire West.

Building Permits:

To round out the picture, the chart below shows the deceleration in residential property building permits (quarterly) among the three regions.  Plainly, the deceleration in permits is primarily in greater Oregon (x-PDX / x-Bend).  I do take issue with Bend's inability to add adequate supply of housing to meet demand.  Although Bend is bordered on the West and South by national forest and to the East by BLM lands, there are still large tracts available for further development.  They may not be the prime Westside locations nestled against the mountains, but significant buildable land and housing will be brought to the market if demand continues.

The chart below highlights the rebound of housing permits (precursor to construction) among the three regions (2015-->Q1 2017 vs. 2005-->Q1 2007).  Portland is approaching record building activity while Bend is still 40% below the housing creation seen during the previous peak...but the rest of Oregon is essentially at a stall (and these are the "good times").

Despite Bend's so-so jobs growth, rental prices consuming record quantities of disposable income, zero real median household income growth, potentially rising mortgage rates, new construction creeping up toward record building, and property values in record should be pretty clear Mr. Valentine's theory is holding water so far.  Bend is a bubble built on a bigger bubble that is still inflating.  Bend's continued appreciation is a bet on a few cities' property values (alongside general financial assets) continuing to rise indefinitely and those wealthy folks continuing to flock to Bend.  So far, so good but the clock is running.  Growth in the cities is simply being borrowed from the rural regions and thus is not a permanent feature, detailed HERE.  Yes, unfortunately Bend is in another bubble and unfortunately this bubble will ultimately pop...but perhaps not before a last blast higher over the next couple of years.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.