Out of the Ashes Rises ... Another Bubble

The Phoenix metropolitan area marks the easternmost edge of the smoking crater that is the epicenter of the housing bust. While nearly every market in America experienced at least a little frothiness in home prices during the bubble, Phoenix, along with Las Vegas, and California's Inland Empire, stumbled into a perfect bubble storm -- bubble conditions reflective of the tight housing markets along the coast combined with building rules facilitating a huge spike in construction. Not only did housing prices overshoot during the bubble; so too did inventory.

The resulting glut interacted with economic recession to produce stunning declines in price. The metropolitan area has seen prices come down just over 50% from the peak. In the hardest hit neighborhoods, declines have exceeded 70%. This has led directly to mass foreclosures. When home values are 10% below loan values, it makes sense to keep paying the mortgage. A household with a loan three or four times the value of their house might not be in the black again for over a decade, and would need to come to closing with a six-figure check should they manage to sell. Better to just walk away.

You'd have thought that the carnage would have ended any taste for real estate speculation in Phoenix. You'd have been wrong. Cash-flow investors looking to buy cheap and attract renters have taken advantage of the thousands of deals on offer daily, thanks to the foreclosure crisis. But the market is beginning to look a little frothy. Bizarrely, deeply underwater homeowners are looking to average down:

Once again, just about everybody seems to be buying as many houses as they can, positive it will make them rich -- or at least allow them to recoup some of their losses.

"I bought too high a few years ago," said Jason Fischbeck, an entrepreneur who lives across the street from Mr. Jarvis and is one of his clients. "It cost $225,000. Now it's worth $110,000. So I just paid $80,000 cash for another. "

Mr. Jarvis, 47, the former co-owner of a wood moulding company that thrived in the boom and faltered in the crunch, also made some mistakes. Last spring, he contracted for three new homes in the distant suburb of Copper Basin, convinced that real estate was bottoming.

He was wrong. He managed to get out of two of the contracts but had to buy one of the houses, which is now substantially under water.

"You need to buy when there's blood in the streets," he said with a shrug. "Even if it's your own blood."

Truly that is the wail of a chastened man. But here's the problem -- Phoenix's housing supply significantly outstripped demand. Even as thousands of housing units were being built, households considering relocation were reevaluating their choice based on a housing stock that was rapidly becoming unaffordable. And at the height of the boom, nearly 10% of the jobs in the metropolitan area were in the construction industry. Those jobs won't be coming back in anything like recent numbers. Many of the people drawn to Phoenix during the boom are likely to be better off picking up and moving elsewhere. And at least some of them are:

A few miles away, the owner of that house with the monstrous power lines, Robert Corr, is being told his house was sold and he has five days to vacate. Mr. Corr smiled when he heard the news, happy to be the latest of the 78,738 foreclosures in Phoenix since January 2005. He had already rented a van to take him and his family back to Alabama, where they would buy a mobile home and live on 10 acres of land.

Brewer Caldwell has bought about 125 houses this year for its clients. Only a quarter had owners who were living there already and willing to stay on as tenants. Filling up the rest, and all the other houses the company intends to buy, will depend on a steady supply of people who cannot afford to buy for themselves.

It's very difficult to work off excess housing supply in an area with declining population -- just ask Detroit. At least the investor above paid for his second home in cash. The difficulty in leveraging up to invest in residential real estate should limit new bubble inflation, and the fallout from additional declines in prices.