L.A.'s house party is about over.

That's the view of the 2006 economic forecast released last week from Chapman University's Anderson Center for Economic Research.

While many economists are predicting a slowdown or even a plateau in housing price appreciation, the Chapman forecast is going a step further and predicting L.A.'s housing market will turn negative by mid-year, with home prices dropping an average of 5 percent by year's end.

That, in turn, is expected to slow the overall economy as consumers pull back on spending, and employment in the booming construction and finance sectors begin to ebb. Overall payroll employment growth is expected to remain sluggish at less than 1 percent, while the forecast predicts taxable sales growth will slow substantially.

The forecast paints a similar picture for the nation, with growth in gross domestic product expected to slow and payroll employment eking out a 1 percent gain. Housing starts are also projected to drop in 2006.

A continued rise in mortgage rates is cited as the primary culprit for the expected national and local housing drops, with higher rates hitting people with existing adjustable rate mortgages hard. Not only will monthly mortgage payments rise, but homeowners will have less ability to take equity out of their homes. That equity has been the basis for a consumer spending spree that has helped prop up the local economy.

Higher rates also will slam first-time homebuyers who have, until now, been stretching to get into mortgages with no down payments or interest-only loans; many may find themselves shut out of the market. As of December, only 11 percent of Angelenos could afford a median-priced home using traditional mortgage loans.

"First-time homebuyers will be in trouble and that's what drives the overall market," said Anderson Center director Esmael Adibi at a Los Angeles Business Journal-sponsored breakfast accompanying the forecast release.

Chapman's housing prediction is more pessimistic than UCLA's Anderson School of Management forecast released in December, which said housing price appreciation will "plateau" in 2006 but still remain positive.

The key variable is whether long-term mortgage rates go up as Chapman has forecast. So far, they have inched up in 2004 and 2005 to about 6 percent; Chapman is predicting a more rapid rise in 2006 to 6.6 percent. If they remain at around 6 percent, Adibi said housing prices might eke out a small gain this year.

Even if housing prices do fall 5 percent, that drop is still small when compared to the doubling of L.A. County home values in the last five years.

But whether house prices flatten or actually drop, Adibi said the impacts will ripple through the local economy. Homeowners will have less ability to tap their home equity for loans that have helped stimulate consumer spending in recent years. As a result, taxable retail sales, which grew at a healthy 7 percent in 2004 and an estimated 6.1 percent in 2005, will grow at only a 4.4 percent rate in 2006, the forecast said.

Employment slowdown
Lower housing prices would also translate into drops in employment for the real estate-driven construction and finance sectors, which accounted for 40 percent of the region's job growth in 2004 and 2005. That will keep the already sluggish growth in payroll employment in check.

According to the forecast, L.A. County will add only 32,000 jobs this year for a growth rate of 0.8 percent. That's up slightly from 0.7 percent estimated employment growth in 2005. But Adibi said that the state is likely to revise upward the 2005 figure; if that happens, the projected 0.8 percent employment growth rate for 2006 would represent a slight slowdown.

An unexpected bright spot in the local economy is manufacturing, especially in the high tech and aerospace sectors. Chapman's quarterly statewide manufacturing index released last week showed the strongest quarterly growth in two years.

Adibi said high tech and aerospace manufacturing should show payroll employment gains this year, helping to offset losses in construction and finance. "Manufacturing is coming back," he said.

Overall, Adibi said, the local employment picture appears stronger than the payroll jobs figures suggest. That's because of substantial gains in civilian employment, which measures jobs held by L.A. County residents. The estimated growth in civilian employment will top 4 percent in 2005.

"Much of this is due to the nature of this employment cycle," he said. "Look at where the employment growth is: in real estate and construction. Real estate agents are self-employed and so are many construction contractors, especially the small ones. They don't show up on company payrolls."

High health care and workers' compensation costs have also prompted many companies to shed full-time employees, making them contract workers, he said.

National growth
Nationally, the Chapman forecast predicts a slowing of economic growth and job creation this year as rising interest rates kick in and consumer spending slows. National gross domestic product, which grew at 4.2 percent in 2004 and at an estimated 3.5 percent in 2005, will only grow 3.1 percent in 2006, the forecast said.

Chapman President and economist James Doti said that in 2004, consumers extracted $600 billion from home equity and spent about $200 billion of that in 2004 and 2005, more than offsetting the impact of higher oil prices.

But, Doti said, this year, rising interest rates mean that consumers will extract much less out of their home equity, which in turn will slow consumer spending. Other signs of a cooling housing market are likely to include drops in housing starts and housing sales volumes.

Doti said another threat to the national economy is the trade deficit, which now stands at 6 percent of gross domestic product. The reason the trade deficit hasn't hurt the economy so far is that China is pumping its trade surplus dollars into U.S. financial markets and investments.

"If China decides to invest its funds elsewhere, all bets are off," Doti said.

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