Are some cities in the U.S. in danger of becoming ghost towns like those in the early west?  The recession and its toll on housing prompted the Mortgage Brokers Association (MBA) and its Research Institute for Housing American (RIHA) to produce A Study of Real Estate Markets in Declining Cities which was released on Friday.

The study, conducted by James R. Follain, Ph.D., Senior Fellow of the Rockefeller Institute of Government uses a detailed statistical analysis of trends over the past 40 years with particularly emphasis on seven large metropolitan areas since 2000. 

Follain said his goal was to offer insights on the potential future evolution of real estate markets in cities that are in the midst of a severe and persistent economic decline. Typically, he said, a declining city is one that suffers a major loss in population owing to a dramatic reduction in its employment base and it has lost comparative advantage in manufacturing.  However, today declining cities "are places that grew substantially during the housing boom and are now experiencing unprecedented declines in home prices and increases in foreclosures."

The author defines a declining city as one in which the people have left, but the houses, apartment buildings, offices and storefronts remain.  While he doesn't expect any major cities or large metro areas to disappear into the desert like the ghost towns of old, he does feel there are neighborhoods and submarkets "that have passed a tipping point" with little prospect of returning to their previous peaks

Follain said his study seeks answers to three questions:

  1. What happens to real estate values in declining cities, especially those areas that have experienced substantial and persistent declines in population and employment?
  2. What is the range of experience for neighborhoods within declining cities?
  3. Do we know enough to be able to confidently predict which neighborhoods are most likely to experience the severe and persistent declines?

The answer to Question 1 is that of course home prices decline in response to substantial and persistent decreases in population or employment because of the corresponding drop in demand for housing.  Where the demand is driven by factors other than population, however, the decline may not be as persistent.  "Hence, the key to any forecast of house prices in many markets today depends upon future housing demand in these markets relative to that reached prior to the Great Recession. 

Follain found that the range of experience among neighborhoods within declining cities was very wide with some experiencing declines so severe that their future viability either seems questionable or that their recovery will be extremely protracted.  But, in answer to Question 3, said it was very difficult to confidently predict whether any decline is permanent or not.  This is particularly troublesome, he said, as forecasts of a persistent decline could be self-fulfilling.  He pointed to the difficulty in assessing vacancy rates, for example, as current methods and models do not account for the fact that there is no one available in a vacant property to provide information on the duration of the vacancy.

Follain said that potential homebuyers and lenders should understand that the future viability of these areas may be threatened by recent economic events and he expects neighborhood choice to become a more important component of housing decisions. "Public policy may be able to play an important role in helping potential homebuyers and lenders make prudent decisions about neighborhood choice, but to do so will require policymakers to tackle difficult decisions about where to target resources." Practical people will also want to see evidence of effectiveness after policies are put in place.

Two policy changes that are discussed by the study are, first, the need for improvement in the aspect of appraisal guidance that calls for an assessment of a property's neighborhood, specifically whether the neighborhood is in decline.  The second is possible modifications in ambitious neighborhood stabilization programs which may help them move neighborhoods toward a more speedy recovery. 

These policy changes are not intended to push lenders to make loans in risky markets he said, specifically addressing Community Reinvestment Act guidelines.  But appraisers and lenders who decide that a neighborhood is on the verge of substantial decline may find themselves challenged on fair lending grounds if that neighborhood has a substantial minority population.  Instead, lenders may need to tighten underwriting standards in all neighborhoods within a troubled metropolitan area until it becomes clear which neighborhoods remain viable.  This, of course, may in itself hinder recovery efforts for those areas most in jeopardy.  The government may be able to help in this area by providing more data, guidelines for forecasts, and evidentiary standards.

Follain also stated a need for "better data and analysis (that) will help everyone become more confident of where we are headed.  Data that assess these (neighborhood stabilization) programs should be made more available to a wide range of institutions committed to objective analysis of these programs.  Absent such information, I fear the recovery will be longer and the number of failed neighborhoods greater than they might otherwise be."

Here is another approach we've recently explored...

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