- Sunbelt cities like Phoenix, AZ have attracted a lot of investor interest in recent years.
- But as home prices soar, many have been left wondering if these lofty valuations are justified.
- Experts debate if Phoenix’s fundamentals can mitigate a crash — or if it’ll soon face a reckoning.
Even as home prices across the United States have catapulted to astronomical heights over the past two years, one region in particular has especially enticed buyers: the Sunbelt.
According to a recent report from Redfin, the top nine US metros where investors held the largest market share during the first quarter of 2022 were all located in the south. The city most popular cities with investors were Atlanta, GA — where they purchased 33.1% of all homes sold — followed by Jacksonville, FL and Charlotte, NC.
Besides an overwhelming investor appetite, the surge in the Sunbelt’s real estate prices can also be attributed to an influx of enthusiastic remote workers with deep pockets. A separate Redfin study showed that migrants’ budgets have far outpaced locals’ by as much as 28.5% in cities like Nashville, TN; Atlanta, GA; and Miami; FL.
But as prices have skyrocketed in these trending metropolitans, homebuyers have also grown increasingly anxious. Fears of a looming real estate crash have heightened as investors debate: Are these sky-high valuations truly justified, or will the housing market once again find itself facing a reckoning?
Diving deep into the Valley of the Sun
To shed some light on this debate, Insider asked seven industry experts to share their views on the real estate market of a particular Sunbelt city — Phoenix, AZ. According to data from Moody’s Analytics, the city — at a 46% overvaluation — currently ranks as the 21st most expensive in the US.
Phoenix, the capital of Arizona, has gone through several tremendous changes in recent decades to attract a bigger population of higher-paid, white-collar migrants. Currently, the average out-of-town budget of $708,911 sits 20.8% the average local budget of $586,706.
Profit margins dipping to a 13-year low also hasn’t deterred investors, who scooped up 29% of total homes sold in Phoenix during the first quarter of 2022 — making the city the fourth largest by investor share in the US. 18.7% of all home sales during that same quarter also comprised of house flips, marking Phoenix as the US metro with the largest home flipping rate, showed data from ATTOM. Besides the city’s promising growth momentum, investors are also attracted by Arizona’s lower-cost, tax- and regulatory-friendly climate and the city’s high quality of life, including new infrastructure expansions on its airport and light rail.
“The Phoenix market was largely a COVID-19 pandemic market until about last summer,” independent real estate market analyst John Wake told Insider, explaining that it was mainly owner-occupants driving the market. “Then it should have been leveling off, except the investor market increased.”
Most of the seven experts Insider spoke to agreed that recent migratory patterns of higher paying businesses and jobs have established solid fundamentals in Phoenix’s local economy. However, they differed on whether or not these demographic shifts have been enough to justify the city’s rapidly appreciating real estate prices — and whether or not these lofty valuations are soon due a swift correction.
An evolving city
By all means, Phoenix’s demographics have undergone a monumental shift in the past decade.
From 2010 to 2020, Phoenix was the fastest growing major city in the US, according to census data. With its metro area now resting at around 4.9 million residents, Phoenix also ranked second for numeric population growth between July 2020 and July 2021, said Origin Investments, a real estate private equity firm managing $1.4 billion in assets.
But beyond this staggering top-line growth, Phoenix’s underlying population demographics have also systemically transformed, said Eric Jay Toll, a representative of the city’s department of community and economic development.
“In 2007, before the great recession, over 50% of our workforce was in real estate, construction, retail, and hospitality. Today, over 60% of our workforce is in advanced business, financial services, technology, manufacturing and bioscience healthcare,” Toll told Insider in a recent interview, pointing to data from CBRE that in 2021, Phoenix led the US in life sciences hiring. “That’s a complete flip of the economy in 10 years.”
According to Toll, this shift was caused by a “conscientious effort” from the city’s government to stop providing incentives to low-wage employers. These efforts seem to be paying off — from 2014 to 2021, the average wage of a new job in Phoenix rose from $36,000 to $72,000, said Toll. Similarly, data from Stessa showed an over 200% increase in the number of six-figure jobs in Phoenix from 2015 to 2020.
Besides its investments into the biosciences and healthcare industry, Phoenix also has a stake in another global sector — semiconductor chip manufacturing. Within the next few years, both Intel and the Taiwan Semiconductor Manufacturing Company have mapped out plans to build billion-dollar plants around the Phoenix metropolitan area, which would also bring another massive influx of new jobs and professionals into the local economy.
But as the average wage in Phoenix has gradually increased, so too have the housing prices and standards for new apartment developments. Compared to the average 17% increase in home prices across the US from March 2021 to 2022, prices in Phoenix jumped 27% in that same time period, said Redfin. Likewise, Origin Investments reported a 27.12% in Phoenix’s rent growth from 2020 to 2021.
According to Toll, a large contributor to the city’s rent growth is because much of its multi-family construction post-2017 has been targeted towards creating the highest-quality rentals, or Class A properties.
“When new Class A apartments come online, they set the standard for what is a luxury apartment. So the luxury apartment that was built in 2008 is no longer a luxury apartment in 2017 and it can’t charge the luxury rents unless they remodel it to meet the new standards,” he explained.
The bear case: Valuations may crater by 25%
As prices soar in Phoenix, more and more tenants are beginning to have problems paying rent, said Nicholas Gerli, the CEO of real estate data analytics firm Reventure Consulting.
“To me, this is like a perfect storm of skyrocketing debt costs for these buyers, softening rental markets in their key cities, and — at the same time — the existing tenant base struggling to pay the rent,” he told Insider in a recent interview.
Additionally, Gerli believes that Phoenix’s “ground zero” status for investors has attracted a furor of speculative behavior that has made the market extremely volatile and will eventually topple its lofty valuations. Phoenix came in fifth on Gerli’s list of the US’s current largest real estate bubbles, based on its average growth of 82.5% in annual house payments between April 2020 and April 2022.
Housing prices in Phoenix have “left Earth’s orbit,” said Wake, who also noted that it’s highly unusual for rents to also take off in a similar fashion. And while today’s housing demand has far surpassed available supply — easing investor fears of another crash — Wake pointed out that housing demand had also skyrocketed up until 2005, when investors began pulling out of the market due to price stagnation.
“There’s just not enough supply, with demand as it is today — but what if it’s not that way in two years? That’s a real possibility, particularly for Phoenix to overbuild new single-family homes for rentals. We could have a ton of supply out on the periphery of town in the new home areas,” he said.
That’s particularly true if an impending recession threatens to slow the job migration patterns going into Phoenix, Wake added. Nevertheless, he doesn’t believe the new businesses currently entering Phoenix’s economy can fully justify the city’s soaring prices and expects them to eventually revert back to the mean, calling a 10-20% correction “reasonable.”
“It’s a lot less than the one in 2005, but nevertheless it would be similar to the correction back then,” he said. “That’s quite feasible.” Recent data from Wake showed that after nearly four years of steady growth, Phoenix home prices may have finally peaked in May 2022. For the first time since 2019, the median price in Phoenix fell by $10,000 in May to rest at $505,000 in June.
Economist and President of Rounds Consulting Group Jim Rounds believes that real estate investors started off in a healthier financial situation than they did in the last housing crisis. But while they may fare better this time around, they’ll still be hurt when the currently vastly overvalued home prices eventually crater, he warned.
“With interest rates going up, that small margin of profit that investors get will be chiseled away. Investor purchases will fall rapidly and the volume of home sales will decline significantly, but you won’t see home prices fall through the floor,” Rounds explained to Insider. “It’s going to gradually go back down over a couple of years, just because this is different from 2008.”
And despite Phoenix’s promising shifting demographics, Rounds still believes that the city’s real estate market is unnaturally overvalued, emphasizing that it takes about a decade for housing prices to organically increase from an economic development surge.
“Every time you create a high-wage job, you create two low-wage jobs. When you average those out, it’s a medium-wage job. You have to do this at massive, massive numbers before you start to see an impact,” he said. “We’re only starting to make a dent in our economic development growth. That’s less of a factor than interest rates and the Fed’s policy.” Eventually, Rounds forecasts a price correction of at least 25% for the Phoenix housing market.
The bull case: Phoenix’s housing market is built on solid fundamentals
While the top line may tell an insular tale of rising rental rates in Phoenix, Toll believes that solely focusing on the average rent may be misleading. That’s because this statistic skews more towards the growing number of luxury Class A apartments coming onto the market, without accounting as much for existing Class B, C, and D properties, he said.
Additionally, Toll also believes that Phoenix’s current economy caters to significantly different sectors than it did in 2007, which would also help the city mitigate a potential crash. His sentiment was echoed by real estate advisor Steve Betts, who also serves as the managing director of development at Holualoa Companies.
“Our economy was really primarily based on our growth industries — developers, homebuilders, construction industry — and a lot of service providers to the growth industry, which caused us to be much more influenced by recessionary periods,” Betts told Insider. “Our economy is now much more based on technology, advanced industrial manufacturing, medicine, and transportation services. The base industry is now really growing the economy, and the development industry is more a service provider to that.”
“We’re building homes, offices, and industrial spaces as a provider to the base industry, as opposed to it being the base industry itself, which I believe makes us much more resilient in an economic downturn, which it appears that we’re headed into,” he continued.
According to Betts, the same principle also applies towards Phoenix’s residential and commercial development strategies. Rather than increasing the number of single-family homes on Phoenix’s outskirts, he said the city has been much more focused on growing its more affordable multi-family and attached product developments inward. Betts estimated that the ratio of single-family homes versus multi-family developments being constructed has shifted from a 90%/10% ratio to a 65%/35% ratio.
“We literally have a tidal wave of employers and new jobs coming to the Valley. With that pipeline of employees coming to the valley, we really have a backlog need for multi-family housing that will take us years to fulfill,” he explained.
But with this crushing demand to meet, Betts doesn’t foresee prices dropping off, but predicts price growth may slow to a more normal pace. In fact, despite Phoenix’s recent price surge, Betts doesn’t believe housing prices are particularly overvalued because they started from an already low base.
“I believe that they are starting to level off at a reasonable price level compared to a lot of our peer cities in the Sunbelt region that we compete against,” he said. However, while government subsidies and focused efforts on new affordable developments can help lower-income workers find affordable housing, Betts expressed concern that the middle-class professionals in the $80,000 to $120,000 area median income range may have been priced out by the recently migrated high earners pushing up Phoenix’s rental rates.
Another positive long-term catalyst for Phoenix is the city’s aging population, said Robby Tandjung, an executive vice president at Altus Group. The city looks particularly attractive to senior citizens due to its relative affordability, lower taxes compared to neighboring California, and its excellent medical services industry, he explained to Insider.
Additionally, if certain industries begin requiring workers to return to the office, Phoenix’s employment diversity might protect its demographics because remote workers won’t be forced to move, said Tandjung. And according to Phil Tily, Altus Group’s head of performance analytics, there’s also one key difference between Phoenix’s housing market today and the one during the great housing crash — currently, demand still runs rampant.
“It doesn’t look as if Phoenix is in a precarious position when it comes to kind of oversupply at this stage,” Tily told Insider.
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