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Cutting back.

In the 1980s, it was Houston, then the Northeast. Now it's Southern California. But where will the worst real estate markets be five years from now? Here are the markets where corporate downsizing, lost manufacturing jobs, and defense cutbacks are delivering the harshest blows.

THERE ARE LONG-TERM CHANGES TAKing place in the U.S. economy--changes that will have a profound effect on the economic health of local real estate and mortgage markets across the country during the next five years. In contrast to economic cycles, these changes are one-way streets--not easily reversed. These changes affect jobs.

There will be job losses in many local markets, which in turn, will affect real estate prices, mortgage demand and the quality of both new and existing mortgages in those markets. There are other forces in the U.S. economy, but these changes will produce some of the worst real estate markets of 1999.

There are three major avenues leading to job losses in the next five years:

* Big defense-spending cuts;

* The loss of U.S. manufacturing jobs;

* The loss of middle management jobs.

These are interrelated because many defense cuts will eliminate manufacturing jobs, and the loss of manufacturing capacity inevitably means that middle managers lose their jobs, too; but they also reflect independent economic trends. By examining each of these one-way streets, we can hone in on those markets most exposed to job cuts.

Defense cuts

Having won the Cold War by forcing the Soviet military to spend the U.S.S.R. into poverty, the United States is now in the ultimately pleasant but immediately painful position of trying to achieve the reverse at home.

During the next 10 years, the United States will be revamping and trimming its military establishment, partly to respond to a new strategic world situation, partly out of economic and political necessity. In an era of massive federal budget deficits, often but mistakenly blamed on huge defense outlays over the last decade, military spending is one area where large cuts are both strategically possible and politically popular.

In the long run, a shift in spending from military hardware to more productive uses will be good for the U.S. economy, but in the short run--during the next 10 years--the effect is more likely to be disruptive for the economy as a whole, and especially for those localities where defense dollars are spent.

There will be manpower reductions and cuts in spending on weapons systems. Some weapons programs will be cut altogether; some will be reduced or stretched out. Congress will probably vote on the recommendations of the Defense Base Closure and Realignment Commission later this year to close a significant number of bases.

Whatever decisions are made this year--about base closings or force reductions or weapons programs--those decisions are likely to meet resistance from powerful interest groups. The pressure to modify or hold off on such decisions will be strong, especially while the national economy remains weak. But the political need to restrain government spending makes sizable defense cuts inevitable. How big these eventually will be depends on political factors, but a 20 percent cut in overall defense expenditures is a good bet.

The scope of defense spending

In 1992, out of a total budget of approximately $300 billion, the Department of Defense spent $74 billion in the United States on salaries for about 2 million employees--both military and civilian. In addition, it awarded $129 billion worth of contracts for weapons, supplies and services that can be traced to specific local markets. The total translates into roughly 5 million jobs that directly depend on defense spending. A cut of 20 percent will mean the loss of about 1 million jobs. (New jobs will also be created, but not in the same places and probably not for people with the same kinds of skills.)

Political considerations and a large web of subcontractors have produced a system of defense spending that is widely--though unevenly--spread across the country. The most total dollars go to California ($34 billion), Virginia ($15 billion), Texas ($13 billion), Florida ($9 billion) and New York ($7 billion). But defense spending has the greatest impact on the local economy in Alaska, Virginia and Hawaii. In these states, defense spending is more than $2,000 per person and produces more than 10 percent of personal income. In another eight states, defense spending per person exceeds $1,000. And there are another 11 states where defense spending per person exceeds $700. As the map in Figure 1 shows, the states with the highest defense spending per person are in New England, the South (with the important exception of Florida), the Southwest and the West.

Of the $34 billion of defense spending in California, $24 billion--about 70 percent--is spent in Southern California, mostly in the greater Los Angeles area. This is very significant in light of the fact that poor economic conditions have already made this one of the worst real estate markets in the country--even before any large cuts in defense spending have been made. In Alaska and Hawaii, most defense spending is associated with military bases. In Maine, Mississippi, Connecticut and Massachusetts, most of the money goes to defense contractors.

Military bases

Military bases have historically been a source of economic stability for local real estate markets because they generate local spending that is unaffected by the usual economic cycles. But bases are now a source of economic anxiety, not only because many of them will be closed permanently, but also because those that remain open will probably get reduced funding.

In addition to its payroll, a military base pumps another 30 percent or so into the local economy in service and supply contracts. The large military presence in Norfolk-Virginia Beach, Virginia, for example, puts a total of $6 billion into the local economy and accounts for more than 25 percent of local income. In this market, roughly 100,000 local jobs depend directly on military spending.

1992 Defense Department Wages and Salaries
Relative to Local Population

 Per Person

Norfolk-Virginia Beach, VA $3,268
Honolulu, HI $2,461
Charleston, SC $2,149
Pensacola, FL $1,674
Washington, DC $1,493
San Diego, CA $1,469
Montgomery, AL $1,442
Vallejo-Fairfield, CA $1,426
San Antonio, TX $1,328
Jacksonville, FL $1,191
Dayton-Springfield, OH $1,123
Columbia, SC $978
Augusta, GA $886
Lake County, IL $876
Bakersfield, CA $855
Harrisburg-Lebanon, PA $794
Omaha, NE $768
Oklahoma City, OK $761
Oxnard-Ventura, CA $749
Salt Lake City, UT $650

The military bases that have been recommended for closure by the base closure commission this year are only the first group in a cycle that most likely will continue for several years. The eventual fate of any one base will not be known for some time. But some defense payrolls are probably quite safe. Large cuts are unlikely at the Pentagon itself (Arlington County, Virginia), and, because of their strategic location, the various facilities in Hawaii should not be significantly affected.

1992 Defense Contract Spending
Counties with Largest Spending

County $ Billions

Los Angeles County, CA 10.8
Middlesex County, MA 3.5
St. Louis City, MO 3.0
Tarrant County, TX 2.9
Santa Clara County, CA 2.8
Cobb County, GA 2.5
San Diego County, CA 2.5
Nassau County, NY 2.4
Orange County, CA 2.3
Fairfax County, VA 2.1
Dallas County, TX 1.9
Fairfield County, CT 1.8
Denver County, CO 1.4
King County, WA 1.4
District of Columbia 1.4
Essex County, MA 1.3
Sacramento County, CA 1.2
Hamilton County, OH 1.1
Montgomery County, MD 1.1
Philadelphia County, PA 1.1

Some of the worst real estate markets of 1999 will be near a major military base that is either closed or sharply reduced in size. Figure 2 shows 20 large markets where defense payrolls are a major source of local income. The Washington, D.C., market includes the large Pentagon payroll.

Defense contractors

In fiscal year 1992, Los Angeles County received almost $11 billion in payments to defense contractors, the largest expenditure in any one county. Next in line, with about $3 billion each, were Middlesex County, Massachusetts; St. Louis City, Missouri; Tarrant County, Texas; and Santa Clara County, California. Figure 3 shows the 20 counties where 1992 defense contract payments exceeded $1 billion. Figure 4 shows the 20 counties where defense contracts are most important to the local economy.

Spending on major weapons systems in 1991 was about $74 billion, of which $24 billion was for aircraft, $16 billion for missiles, $15 billion for electronics, $9 billion for ships and $9 billion for tanks, guns and ammunition. The initial intention of the Defense Department is to cut ground forces while keeping air and naval capabilities high, but the big dollar savings are in the weapons programs, and almost all of them will eventually be cut back.

1992 Defense Contract Spending
Relative to Local Population

County Per Person

St. Louis City, MO $7,527
Cobb County, GA $5,604
Arlington County, VA $4,065
Greene County, OH $3,617
Alexandria City, VA $3,604
Newport News City, VA $3,581
Denver County, CO $3,092
Norfolk City, VA $2,623
Fairfax County, VA $2,604
Middlesex County, MA $2,483
Tarrant County, TX $2,479
Brevard County, FL $2,443
District of Columbia $2,361
Fairfield County, CT $2,159
Santa Clara County, CA $1,890
Essex County, MA $1,884
Nassau County, NY $1,882
Santa Barbara County, CA $1,849
Burlington County, NJ $1,797
Guilford County, NC $1,782

Some of the worst real estate markets of 1999 will be those that lose major defense contracts. Figure 5 shows the 20 cities or local markets that currently have the highest defense contract spending per person. The high amount for Melbourne, Florida, is linked to Cape Canaveral. Spending in Norfolk-Virginia Beach is both for supply of the various military facilities and for shipbuilding.

Effects on local real estate markets

In markets where military bases are closed or reduced in size, the effect on real estate will be indirect, because military housing is usually located on the base. The loss of the military payroll, spread over many retail businesses, will produce job losses mainly among lower-paid retail workers--who often don't own homes. In the long run, home prices will be kept in check and demand for new housing will be slow, but there will not be a wholesale real estate recession unless the base is a major source of local income.

1992 Defense Department Contract Spending
Relative to Local Population

 Per Person

Melbourne-Titusville, FL $2,443
Fort Worth-Arlington, TX $2,178
Fairfield County, CT $2,159
Santa Clara County, CA $1,890
Washington, DC $1,870
Santa Barbara, CA $1,849
Boston, MA $1,369
St. Louis, MO $1,350
Norfolk-Virginia Beach, VA $1,299
Los Angeles-Long Beach, CA $1,219
Fort Wayne, IN $1,176
Wichita, KS $1,165
Palm Beach County, FL $1,115
Tucson, AZ $1,099
Nassau-Suffolk, NY $1,093
Denver, CO $1,076
Atlanta, GA $1,020
San Diego, CA $993
Sacramento, CA $984
Trenton, NJ $968

The loss of major defense contracts can have a more devastating effect on local real estate because many of those losing their jobs will be high-paid engineers and technicians who are homeowners. Because of their skills, these people are quite likely to find new jobs, but in other markets. The loss of major defense contracts will result in delinquent mortgages, foreclosed properties--and falling home prices.

The loss of U.S. manufacturing jobs

Additional forces at work in the U.S. economy will produce other types of cuts that will prove material to the strength or weakness of various real estate markets.

Manufacturing provided 27 percent of all American jobs in 1970, slipping to 22 percent in 1980 and only 17 percent in 1990. At the same time, service jobs increased from 16 percent to 27 percent. There are about the same number of manufacturing jobs today as in 1965. Even now, as the rest of the United States recovers from the 1991 recession, manufacturing jobs are disappearing at the rate of 2 percent a year.

While the loss has been most severe in industries such as basic metals or transportation, the damage is really across-the-board. It reflects a fundamental erosion of competitiveness that will continue during the next decade, as more manufacturing capacity is moved to low-wage countries. The North American Free Trade Agreement (NAFTA)-- the "giant sucking sound going South," as Ross Perot described it--and the new availability of cheap labor in Eastern Europe and the Far East, will accelerate a process that has already taken steel, textile, automobile and electronics jobs out of the U.S. economy.

The erosion of manufacturing capacity has been dramatic in several states. The percentage of jobs in manufacturing in North Carolina dropped from 40 percent in 1972 to 27 percent in 1992. The drop was from 35 percent to 23 percent in Michigan, 34 percent to 20 percent in Connecticut, and in New Jersey the drop was from 30 percent to just 15 percent.

Since 1987, more than 10 percent of the manufacturing jobs have been lost in California, New England, New York, New Jersey, Maryland and Hawaii. More than 25 percent of the manufacturing jobs have been lost in Nassau-Suffolk, New York (Long Island); Bergen-Passaic, New Jersey; Boston, Massachusetts and Fairfield County, Connecticut.

The worst real estate markets of 1999 will prove to be those that currently have a large manufacturing base. As shown on the map in Figure 6, manufacturing accounts for a high proportion of jobs in states east of the Mississippi. In four states, Arkansas, Indiana, Mississippi and North Carolina, more than a quarter of all jobs are in manufacturing. Very few markets in the West have a similar concentration.

Figure 7 shows the 24 markets that have more than 20 percent of their jobs in manufacturing. Only two, Santa Clara County and Modesto, California, are in the West. Seven markets have concentrations in excess of 25 percent. They are: Rochester, New York; Grand Rapids, Michigan; Greenville-Spartanburg, South Carolina; Greensboro-Winston-Salem, North Carolina; York, Pennsylvania; Santa Clara County, California, and Johnson City, Tennessee.

Corporate downsizing

Defense contractors are in the forefront of a legion of major corporations that are restructuring their operations to make do with fewer employees. But we are also seeing major downsizing in previously invulnerable companies. General Motors Corp., International Business Machines Corp. (IBM), E.I. Dupont de Nemours & Co., Eastman Kodak Company, General Electric Co. and The Boeing Co. head a long list of corporations that are shedding jobs in order to compete more effectively in the future.

There are many reasons companies are deciding that they have excess workers. One is that the 1991 recession showed how far companies must cut in order to be profitable even in lean times. Another is that, as in the defense industry, market demand for some products is undergoing a fundamental shift. This is most easily seen in the computer industry, where technology has progressed to the point that the hardware produced by industry leaders such as IBM and Digital Equipment Corporation is becoming a low-priced commodity, while the value-added business is coming from chips (Intel Corp.) and software (Microsoft Corp.).

Corporate restructuring used to translate to production workers getting the ax, but the current trend in corporate downsizing--whether through pink slips or early retirement packages--is to take big bites out of middle management as well.

Big companies with many layers of management are finding that they can be more efficient if they shorten the distance between executive decision makers and front-line production workers, whether in a factory or a bank. With the spread of computer technology, some of the old functions of middle managers--passing reports and information up to senior managers and relaying orders back down the ranks--can often be eliminated. More fundamentally, as big companies such as GM lose market share to more nimble competitors, they just don't need as many managers to oversee a shrunken manufacturing capacity.

Some of the worst real estate markets of 1999 will be those that today have a high complement of middle managers. Middle managers own homes. The loss of their jobs will have a direct effect on local real estate values, particularly since they aren't shy about packing up and moving to a market with better opportunities. Identifying markets with a high proportion of middle managers is a bit tricky, but a good indication of the presence of middle managers (which the government doesn't track) is the presence of business support services (which the government tracks in great detail). Figure 8 shows the 20 markets with the highest concentration of business support services.

The worst markets of 1999

So, taking all these factors into account, what will be the worst real estate markets of 1999?

With its very high reliance on defense spending, Norfolk-Virginia Beach is my top pick. Though unlikely to be closed, the military facilities will suffer a reduction in both payroll and local supply contracts. As many as 20,000 local jobs could be lost.

Melbourne-Titusville, Florida, is next on my list because of the large amount of defense contracting there, the presence of Cape Canaveral and the high concentration of white-collar jobs. In addition to defense cuts, there are likely to be job losses from a scaled-down NASA (National Aeronautics and Space Administration).

Santa Clara County, otherwise known as San Jose, is also near the top of the list. The area economy is fueled by a substantial amount of defense contracts, a lot of manufacturing jobs and a lot of white-collar jobs. It is already a poor market for real estate that will get worse.

Next comes Southern California. The area is already in a recession, and real cuts in defense spending haven't even begun. Real estate cycles can be very long--look for real estate, in general, in this market to continue on its knees through 1999.

1992 Manufacturing Jobs
As % of Total Jobs

Johnson City, TN 31%
Santa Clara County, CA 30%
York, PA 30%
Greensboro-Winston-Salem, NC 29%
Greenville-Spartanburg, SC 29%
Grand Rapids, MI 28%
Rochester, NY 27%
Allentown-Bethlehem, PA 25%
Aurora-Elgin, IL 25%
Fort Wayne, IN 25%
Wichita, KS 24%
Augusta, GA 23%
Charlotte-Gastonia, NC 23%
Akron, OH 22%
Chattanooga, TN 22%
Dayton-Springfield, OH 22%
Detroit, MI 22%
Fairfield County, CT 22%
Gary-Hammond, IN 22%
Lake County, IL 22%
Milwaukee, WI 22%
Scranton-Wilkes-Barre, PA 22%
Ann Arbor, MI 21%
Modesto, CA 21%

With the largest concentration of white-collar workers in the country and $7 billion in defense contracts, the greater New York City area--including northern New Jersey, Long Island and Fairfield County, Connecticut--is also in for an extended real estate recession.

Figure 9 shows my complete list of predictions for the 20 worst real estate TABULAR DATA OMITTED markets of 1999. Two markets not on my list are Washington, D.C., and Honolulu. Spending in Washington, in my view, will not go down and white-collar government jobs will not be cut, in all probability. Because of strategic location, the military facilities in Honolulu most likely will not be reduced; and in any case, the Hawaii real estate market is much more tied to foreign investment than to local defense spending.

A restructured economy

We are in the middle of an accelerated restructuring of the U.S. economy in response to large economic and social forces. The economy is always changing as technology and consumer tastes evolve, but the last 20 years have produced new factors that are adding new pressures. A long period of peace has produced vigorous, low-cost manufacturing economies in Asia. The demise of communism in Europe and the rise of well-armed dictators elsewhere has changed U.S. security requirements. New information technology has speeded up the pace of business. The aging of the baby boom generation is increasing the demand for health care.

These factors translate into bigger-than-usual changes in the types of jobs that are needed and available in this country. For this reason, real estate markets will be unusually vulnerable over the next 10 years as these changes get sorted out. Investments in buildings, manufacturing plants and people aren't very mobile, so the process of change takes a long time and may not be very noticeable unless you take a step back to get a better perspective. But the changing job requirements in the economy--and the implications for real estate markets where those jobs will or won't be--seem clear.

I have focused on those real estate markets where the vulnerabilities are greatest, but the changing economy is also creating new opportunities. For example, since 1987, service jobs grew by more than 35 percent in Washington, Idaho, Utah, Arkansas, Tennessee, North Carolina and Mississippi. Service jobs grew by 40 percent in Orlando, Sarasota, Las Vegas, Raleigh-Durham, Knoxville and Little Rock.

Health care jobs have been growing more than 4 percent a year, even during the recession; markets such as Birmingham, Little Rock and Pittsburgh have added new jobs because they have become major regional medical centers. And manufacturing is doing well in some areas too; since 1987, manufacturing jobs have increased more than 10 percent in Nevada, Utah, Wyoming, Nebraska and Louisiana. There's much more to be said about the good prospects in these markets.


White-Collar Job Concentrations

Melbourne-Titusville, FL Albuquerque, NM Washington, DC Monmouth-Ocean, NJ San Francisco, CA Middlesex-Somerset, NJ Lake County, IL Santa Clara County, CA Boston, MA Trenton, NJ Newark, NJ Bergen-Passaic, NJ Fairfield County, CT Dallas, TX Orange County, CA Chicago, IL Santa Barbara, CA New York City, NY Raleigh-Durham, NC Oakland, CA

Ingo Winzer is the editor of the National Review of Real Estate Markets, published by his firm, The Local Market Monitor, in Wellesley, Massachusetts. He is a graduate of MIT and the Boston University Graduate School of Management. (The data on defense spending in this article is taken from Consolidated |Incomplete Text In Original Publication~
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Title Annotation:Cover Report: State of the Industry; real estate and mortgage markets
Author:Winzer, Ingo
Publication:Mortgage Banking
Date:Oct 1, 1993
Previous Article:King of the Hill.
Next Article:A balanced response.

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