November 14, 2016

Each morning on his way to work at City Hall, Seattle’s budget director Ben Noble bikes past two under-construction office towers. Both are slated for completion next year, Noble says, and both “are going to deliver a lot of product to the market.” But he adds, neither building is “fully leased, by any means.”

Such details matter to Noble. With construction now accounting for a record 26 percent of the city’s retail tax revenue (and roughly a quarter of Seattle’s $25 billion retail economy), any sign of weaker demand for office space or housing gets the city’s attention. And such signs are mounting.

This summer, Noble says, city analysts began to see data, including a decline in building permits, suggesting that the city’s extraordinary construction boom is finally headed for a slowdown.

To be clear, the city isn’t anticipating a repeat of 2008, when the financial crisis caused construction to grind to a halt. The new forecast, issued by Noble’s office in late September (and echoed by King County and several private forecasters) predicts a soft landing: a nine percent decline in construction through 2019, coupled with an even more modest cooling in the city’s broader economy.

Still, given that Seattle’s construction sector has grown by an average of 16 percent every year since 2011, even a soft landing may well be jarring.

For that matter, the mere suggestion of a slowdown will be jarring. It’s likely to add to tensions between city councilmembers and Mayor Ed Murray over the current budget process. Already, Murray has used the downturn to push for a leaner budget that “avoids making too many major new long-term commitments.”

More to the point, the new forecast is at odds with what is, by all appearances, a regional economy nowhere near a slowdown. Not only is the Seattle area generating jobs at twice the national rate and attracting big-name companies (most recently, Apple); but that stellar performance has lasted longer than conventional economic models would have predicted.

Twelve months ago, Noble issued a similar forecast for a regional downturn, but had to revise it after yet another surge in tech hiring reignited demand for homes and office space.

And there’s rub: while economists start to get nervous when booms stretch past the historic average (around eight years), the opposite is true for most people. The longer the good times keep rolling, the easier it is to buy into the fantasy that they’ll keep rolling, that our tech-fueled economy is, somehow, becoming untethered from national trends and historic cycles. Or as the recent Delta Airlines ad insists, “You can’t stop Seattle.”

In the collective conversation about this region’s economy, says Kris Ritchey Curtis, a partner at the Seattle real estate brokerage Kinzer Partners, “it’s almost as if there’s the Seattle world and then there’s the rest of the world.”

We’ve heard the story before about tech-powered economic miracles — and it didn’t end especially well. During the late 1990s, the region was lifted to greatness by another tech boom, this one driven by “dot.com” companies. The sector was bigger here, as a percentage of the region’s economy, than just about anywhere else in country, according to Dwight Dively, Noble’s predecessor at the Seattle budget office.

And while that lopsided presence made the good times really great, it also ensured that the subsequent tech bust in 2001 was all the more devastating.

Regional job losses then “were almost as bad as the Boeing bust of 1969, and it took a very long time to climb back out of it,” says Dively, who now runs the King County budget office. Regional construction spending didn’t recover its pre-bust high, in inflation-adjusted terms, until 2006, just as the housing market was turning into a bubble.

Certainly, there are significant differences between the dot.com sector of the ‘90s and the tech sector of today. But given how central the tech sector is to our economic boom, it’s worth taking a closer look at just how special our economy actually is.

A UNIQUE VULNERABILITY



What makes this question so complicated is that the regional economy really does enjoy some serious advantages. Our natural resource base and environmental amenities, our export-friendly location, and, especially, our highly educated workforce and critical mass of name-brand, export-oriented companies have enabled the region to grow at a rate that is well above the national average during the last half-century, says Seattle economist Dick Conway.

These local advantages will very likely keep Puget Sound ahead of the national curve for decades to come, he says. The caveat here is that while we’ve beaten the national economy over the long-term, our region suffers short-term swings more extreme than the rest of the nation, thanks in large part to these same regional characteristics.

In the late 1960s, for example, a relatively modest national recession resulted in a local disaster: the recession hurt global air travel, which led to massive job cuts at Boeing and the most severe downturn of any U.S. metro area since the Great Depression.

Likewise, the savings-and-loan housing bust of the late ‘80s was disproportionately brutal here because it dampened the nation’s demand for our timber. As with the rest of our economy, says Conway, “our recessions tend to be idiosyncratic.”

Given that history, you’d think we would automatically regard our booms with suspicion. Instead, we quickly forget the bad times, in part because our recoveries are also idiosyncratic: according to Conway, we come back from recessions faster than the rest of the nation does and typically go on to reach higher highs, relatively speaking.

Because these rapid recoveries tend to be connected to our local advantages, it’s much easier for us to imagine that each upswing is, somehow, especially durable.

That was certainly the case after the Great Recession, when the region got an early lift from record-setting job growth. Because so many of those jobs were, and still are, coming from tech sector actors like Amazon — and because that sector behaves so much differently than other sectors — we’ve found it remarkably easy to treat the current boom as not just another cyclical upswing, but something more permanent.

And, to be sure, tech is different, in many important ways. The most obvious distinction is its high salaries, which have revved up our regional economy, especially housing. Further, tech firms tend toward a geographic herd mentality, known as agglomeration. The Microsoft miracle of the ‘80s drew dozens of other tech firms to the region “not necessarily to do business with Microsoft, but to be close to the pool of skilled workers, or be in the vicinity of where new technology is being developed,” says Conway.

Arguably, agglomeration is even a stronger force today. Thanks to Amazon in particular, the region enjoys a critical mass of talent that, in this era of skill shortages, tech firms need to be close to. That’s a big reason Google and Facebook are here, and why Apple is looking for office space for reportedly up to five thousand employees.

It also helps explain why developers have been pumping out new office space — and why they’re so confident that housing demand will remain high. According to real-estate market analyst Dupree Scott, developers expect to bring another 25,000 rental units online by 2019.

As icing on our tech-centric economic cake, many of our tech firms sell products with inherent long-term growth potential. The cloud computing market Microsoft and Amazon are battling over has decades of growth ahead. And, importantly, because many of these products help consumers and business customers cut costs, demand will theoretically increase even if the national economy slips into a recession.

Concepts like agglomeration and recession-proof services might feel pretty speculative – they are. But throw in some statistics about the number of construction cranes in the city (top in the nation) or wage growth in the Seattle metro area (nearly a percentage point above the natural average), add some stories about thousands of unfilled local tech job openings and the steady influx of Asian millionaires, and finish with woeful accounts of soaring home prices and worsening traffic, and it’s hardly surprising that the idea of Seattle exceptionalism has become so normalized.

After five years of rocket-powered growth, says Seattle real estate consultant Brian O’Connor, it gets easier and easier to imagine a scenario where “the nation could fall into a little downturn, but maybe the tech economies on the West Coast don’t really feel it.”

SMALL CHANGES, BIG SLOWDOWN



Of course, having lived through three local downturns, O’Connor readily concedes that the “don’t really feel it” scenario falls apart in the event of a serious national recession. In fact, even the most optimistic Puget Sound real estate players adhere to what might be called a hedged exuberance, wherein the local economy defies national trends unless something really bad happens – another financial meltdown, say, or the collapse of Amazon or of Boeing. But we might not need an epic disaster to nudge the regional economy out of its high-altitude orbit.

As Conway points out, if you subtract the growth we get from our two big job generators — Boeing and the tech sector — the local economy suddenly looks a lot like the national one, which is still limping along at an anemic growth rate. And some of that subtraction is already happening. Boeing is now shedding thousands of jobs and may keep doing so for several years—which means that our regional specialness rests evermore heavily on the tech sector.

That’s fine as long as tech maintains its current, extraordinary job growth. But any serious tech hiccup — meltdown at Amazon, say, or the departure of tech firms for other, more affordable, less congested cities — would have disproportionately massive impacts on our economy, and by extension our construction and housing sectors.

Even without a serious hiccup, Amazon and many other tech firms may be challenged to keep delivering the current massive rates of job growth. For one thing, many of the “new” jobs these companies have added since the recession weren’t truly new, but were old jobs lost during the crash. And as the thousands of unfilled tech openings attest, pre-existing jobs tend to be easier to fill than new or “organic” ones. The effect could be compounded at Amazon, which has long traded profits for rapid growth, but which could eventually be pressured by shareholders to slow growth and boost profits.

For another, there is no guarantee that the agglomeration dynamic will continue to bring new tech firms to the Seattle area, particularly if housing affordability and traffic congestion continue to worsen.

And there are still plenty of basic business risks that even the most robust tech sector cannot spare us from. Take the so-called wage-rent gap. Much of the recent wave of apartment construction rides squarely on rising wages – and, more precisely, on the expectation that steadily rising wages will enable workers to pay the steadily rising rents that developers need to build more apartments.

But while wages have been soaring (3.6 percent annually in the Seattle metro area) they’re not rising nearly as fast as rents (9.7 percent) or home prices (11.8 percent). “You see rents growing at 15 to 20 percent over the last two years, but show me where incomes have gone up to match,” says Mathew Gardner, chief economist at Windermere. “They haven’t.” That’s one reason Gardner predicts a local downturn by 2018.

The rent-wage gap was one of the warning signs, largely ignored, that the housing boom of the early 2000s was actually a bubble. And while we’re probably not in bubble territory this time, the wage-rent gap is already weighing down parts of the local rental market. In hot submarkets such as Belltown and South Lake Union, landlords are no longer able to raise rents as fast as they could even last year, according to commercial real estate brokers. Many managers are offering concessions, such as a month’s free rent, to fill their buildings.



Softening rents in a few neighborhoods isn’t proof that the rental market is about to collapse, or that cheap rent and affordable housing are just around the corner: rents are still rising in many other parts of the region, according to Gardner. But it’s also the case that when rental markets do shift directions, the tipping point often comes first in high-end neighborhoods (where developers probe the market’s upper price bounds), before rippling outward to lower-priced neighborhoods.

In other words, the astronomical rents being charged in places such as South Lake Union or Capitol Hill could mark the earliest stages of peak rent in Seattle. While Zillow forecasts rents in the Seattle Metro area to grow at a very painful 7.2 percent next year, that’s still down from this year’s even more painful rate of 9.7 percent.



One final piece of evidence that we’re not invulnerable to a slowdown: investors aren’t as hot on Seattle as they once were. Until fairly recently, banks, pension funds, Asian billionaires, and other players in the global capital markets couldn’t get enough Seattle-area assets. Our tech-hub narrative, coupled with a shortage of other global investment opportunities, led investors to pour money into virtually any high rise or office building that a developer might propose, a success that only burnished the region’s reputation as a growth machine.

But those glory days are fading a bit. Banks have become more cautious in financing construction projects in the Seattle area, and now typically charge a higher interest rate or demand a larger equity stake from the developer. As one veteran Seattle developer puts it, “where banks were throwing money at me to do a project a year ago, now they’re looking at everything with very suspicious eyes.”

Likewise, when developers put their completed office towers or apartment buildings on the market, they’re now getting fewer buyout offers. No local buildings have gone unsold, but as Jon Hallgrimson with real estate company CRBE puts it, “instead of maybe ten or twenty investors chasing the same property, now it’s half a dozen or maybe even just two or three.”

This, too, isn’t necessarily a sign of imminent collapse. Dylan Simon, a Seattle multifamily broker, correctly points out that any reluctance of bankers or other capital providers is the market’s way of rebalancing the construction sector. The fact that a shortage of debt capital may be forcing developers to delay projects, or even push them to the next cycle, means the volume of “product” hitting the market will moderate.

THE CAUTIOUS PATH

That’s a good argument for a soft landing. Still, no one who endured the meltdown of 2008 can forget how quickly a gentle rebalancing of the market can turn into a bloodbath when banks and investors flee the construction sector en masse.

Although Noble is careful to say that he is not anticipating another financial crisis, he acknowledges that a bigger-than-expected pullback by capital markets could cause a major downturn in the local economy, as opposed to a soft landing.

At the end of the day, observers of Puget Sound’s economy are left with a paradox. On the one hand, the experience of the past few years suggests that we may be living in a truly extraordinary period, when conventional economic rules are, if not suspended, at least partly rewritten. But on the other, one needn’t go back too many years to see how easy it is to mistake the exception for the rule.

This uncertainty is a major problem for anyone in with a commercial interest in the economy, whether that be a developer considering a new project or a homeowner wondering whether to sell now or hope for another year’s appreciation. But the uncertainty is especially onerous for local governments trying to gauge their revenues over the next few years.

Again, the dot.com episode is instructive. The booming tech sector brought not only a huge windfall in government tax revenues, but also a narrative, pushed hard by tech-industry visionaries, about how the new digital economy had rendered the business cycle obsolete.

That potent combination helped encourage some serious government overspending, not least by the City of Seattle. At one point in the late 1990s, Dively recalls, city officials “actually approved every single request that a department head submitted — nobody got a ‘no’ — and there was still money left. But rather than saving it, it was, ‘Oh, no, the business cycle has been repealed, so it’s going to be good forever – let’s add more stuff.’”

When the bubble burst in 2001, Dively says, city tax revenues plunged, and City Hall was forced to make painful cuts. “You were closing community centers,” Dively recalls. “You were closing pools, you were cutting way back on maintenance; you didn’t have the investment in streets or roads like we needed. We actually looked at cutting firefighters and police, [which led to] an absolute war. It was really bad.”

No one is predicting a reprise of the 2001 crash, in part because local tech sector is far more stable. But some local governments are already taking a more cautious line on prospective revenues. It’s a stance that will receive plenty of pushback from some politicians and advocates, who fear this new fiscal caution means lost chances to address serious social problems, such as homelessness, before they get even worse. Noble, for one, readily concedes that his new forecast may be too conservative, not least in underestimating the tech sector’s specialness.

But given the costs of over-optimism, it’s a chance he’s willing to take. “I will happily take the risk of our tech sector doing better than we thought,” says Noble. “But from a forecaster’s perspective, I’m certainly not going to count on it.”

--

Paul Roberts is a journalist and author whose work has appeared in Rolling Stone, Harper’s, the Washington Post, Newsweek, the New Republic, and more. He covers energy, technology, and consumer culture. His latest book, “The Impulse Society: America in the Age of Instant Gratification,” was published by Bloomsbury USA last year. He can be reached via editor@crosscut.com.

Lead image of Amazon construction by Frank Fujimoto.