Oil Crisis and Real Estate: Economic Commentary

Sometimes Things Are Not What They Seem

Two trends many are following recently: higher oil prices and lower real estate prices. Many are concerned that we are heading to $4.00 per gallon gas and a double dip in housing prices. However, we caution observers to look beyond the headlines. Let’s start with oil. At the onset of the fiscal crisis, oil prices plummeted. And they plummeted just after spiking up to around $130 per barrel. Oil prices have been rising ever since in line with the recovery from the recession. A stronger economy translates into more demand for oil. However, with the political turmoil escalating in the previous two months, the rise in oil prices has escalated as well. Analysts are not all on board with this escalation. For example, Fortune reports: Given that Libya represents less than 2% of global production and that the IEA has over 1.6 billion barrels of oil in storage, clearly the current price movement is about more than Libyan disruption. Even if Libyan oil production were completely turned off, the IEA has enough oil in storage to offset that lack of production decline for a full year. Further, it is estimated that OPEC collectively has between 4 and 6 million spare barrels of daily production. The article concludes that oil is trading not on fundamentals, but fear. Assuming that Libya stabilizes either under the present or a new regime, the country will realize quickly that producing oil will help them rebuild. The result could actually be more production of oil, not less. This means that oil prices could finish the year lower than where they are now. We are not saying that is going to happen, but many analysts believe this to be the case, especially if the crisis does not spread to Saudi Arabia.

Now real estate. We had a similar bubble which burst in real estate around the time of the fiscal crisis and recession. Real estate prices do not move as quickly as the stock market or oil and therefore the rise and fall was more gradual and less pronounced. Like oil, the price of real estate has been recovering over the past two years. However, this recovery was pumped up by the existence of tax credits and other government subsidies. Everyone knew that when the tax credits ended that there would be a negative effect on the real estate market. Therefore, the second half of 2010 saw the real estate market, including prices, weaken. Some have said that this is the beginning of a “double dip” in prices. Again, we caution observers to keep an open mind. While real estate will be weighed down by shadow inventory and a steady stream of foreclosures for some time, the one factor the real estate market needs in place in order to reverse the slide is a stronger employment picture. This appears to be happening with the unemployment rate and weekly employment claims sliding. A few stronger months will not get the economy turned around, but it appears we are heading in the right direction. If people can get jobs, kids will move out from their parents’ houses and household formulation will increase. We are not building enough homes to accommodate this latent demand. Even those who were foreclosed upon will need houses to rent. The conclusion? If the economy continues to progress thorough 2011, the real estate market could turn around quicker than the doomsayers expect.

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