Business & Real Estate

Sacramento’s economy is booming. But is a recession on the horizon?

The 5 fastest growing economic sectors in the Sacramento region

In the past five years, some of the fastest growing economic sectors in the Sacramento region include construction, health care and food. See where they rank.
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In the past five years, some of the fastest growing economic sectors in the Sacramento region include construction, health care and food. See where they rank.

It’s only a matter of time. Job growth and housing prices will falter, unemployment rates will rise and the state budget will start bleeding red ink again.

Sacramento will find itself in another recession.

After a decade of expansion, many economists believe a recession could arrive in the United States by 2020, taking California and Sacramento along with it. While it probably won’t be as severe as the last one, it could leave Sacramento susceptible to some of the same forces that brought the economy to a screeching halt a decade ago.

The greatest vulnerability may reside in the state budget. California boasts a fat surplus for now, but its tax revenues are notoriously volatile, and Gov. Jerry Brown has warned repeatedly that a downturn is coming. Although the state is socking away $16 billion in reserves, the Legislative Analyst’s Office says even a “mild” recession would deprive the state of billions in tax payments. State hiring almost certainly would lag, and Sacramento, still largely a government town despite efforts to diversify, would suffer.

A recession could crimp another fuel line that has been key to Sacramento’s recent economic success — the influx of people and businesses leaving the Bay Area in search of lower costs. Economists believe the next economic slump will cool the Bay Area’s red-hot tech sector and diminish Sacramento’s role as a landing spot for San Francisco exiles.

California’s boom-and-bust tendencies also likely will play an outsized role — both in Sacramento and beyond. The state’s economy relies on a mix of industries that makes it more dynamic, and more erratic, than the nation as a whole. California’s unemployment rate soared higher than the U.S. average in each of the last three recessions. That could happen again.

“California always has very tough cycles,” said Barry Broome, who runs the Greater Sacramento Economic Council and leads the region’s efforts to expand its corporate base. “We always boom more than everybody else, and we usually get hit harder than everybody else. San Diego, L.A., the Bay Area and Silicon Valley as well as Sacramento tend to get hit harder in recessions than other places.”

That doesn’t mean Sacramento is necessarily doomed to a repeat of the Great Recession, when unemployment topped 12 percent, foreclosures littered the landscape and state workers stayed home on “Furlough Fridays.”

The key difference this time: There’s little evidence of another housing bubble. Although rents have risen sharply and home prices in Sacramento are the highest they’ve been in 12 years, analysts say the increases are the result of job and income growth, not the shoddy lending practices of a decade ago. On a statewide level, contractors are building barely one-third as many homes as they did in 2005, when the housing boom peaked, according to the California Building Industry Association.

That suggests the landing won’t be as hard this time.

“You haven’t seen a lot of speculative construction; we haven’t overbuilt,” said Sacramento developer Mark Friedman, who has spearheaded such major residential and mixed-use projects as the Bridge District in West Sacramento and the Ice Blocks in downtown Sacramento. “We aren’t going to see the same dramatic downturn in real estate.”

The construction industry is hardly idle. Development is bubbling up all over the region, from the 11-story apartment tower rising at 19th and J streets in midtown Sacramento to the model homes sprouting at Folsom Ranch, a community of 25,000 people starting to take shape south of Highway 50.

Unemployment fell to 3.3 percent in greater Sacramento earlier this year, the lowest since the current calculation methods began in 1990. Although the rate rose to 4.1 percent in June, payrolls continued to expand. In July, a Bay Area tortilla manufacturer announced it was expanding into Elk Grove and plans to hire 250 workers. Sacramento city leaders continue to work with St. Louis health insurer Centene Corp. on its tentative plans to build a 5,000-employee regional headquarters in Natomas.

Hardly sounds like a community about to head into a recession. By practically any measure, the immediate outlook is bright for Sacramento and the rest of the state, said Chris Thornberg of Beacon Economics consulting in Los Angeles.

Nevertheless, many of the people who are paid to worry about such things say a downturn is coming at some point. Experts surveyed recently by the National Association for Business Economists pegged the start of the recession by the end of 2020. Nearly half the experts surveyed in May by consulting firm Pulsenomics LLC for real estate researcher Zillow said the recession will begin in early 2020.

Alarm bells have been ringing in the Capitol for some time. Brown has been pleading with the Legislature to stockpile tax revenue in anticipation of another recession. “Life is very giddy at the peak ... but I’m not giddy,” he said during a budget presentation in May.

Irena Asmundson, chief economist at the Department of Finance, said the state isn’t actually forecasting a recession but believes history makes a downturn highly probable. The economic expansion is 9 years old, nearly matching the longest ever.

“It would be a new record to go past 10 years,” she said.

Expansions don’t die of old age. Something has to happen. Experts say the trade war launched by President Donald Trump, if it escalates, could be the factor that triggers the next recession.

It could hit some of California’s key industries hard. The state’s dairy farmers already are lamenting the potential loss of export markets, and Los Angeles economic consultant Sung Won Sohn said the tech sector could be “one of the primary casualties” if trade sputters with China and other crucial markets.

That could be problematic for Sacramento, which has come to rely on the population exodus from the Bay Area for some of its economic lift, especially in the past year. “We’ve seen it increase pretty substantially ... the last three to six months, nine months,” said Greg Paquin, a consultant who analyzes the home-building market in greater Sacramento.

He said it’s difficult to say, however, how much a Bay Area slowdown would affect the Sacramento economy.

A new economy?

One of those Bay Area refugees, tech entrepreneur Garrett Larsson, knows a recession is coming — “there’s going to be one, there always is,” he says — but he’s too busy writing the next great Sacramento business success story to give it a lot of thought.

Larsson is co-founder of Rhombus Systems Inc., a Sacramento start-up that makes security cameras capable of facial recognition and other high-tech features. Whether companies like Rhombus can succeed will go a long way toward determining whether Sacramento can create a more robust industrial base — and an economy that’s better equipped to withstand the next recession.

Rhombus is part of a new wave of tech companies in the region. It employs just 12 workers but expects that figure to grow before too long.

Larsson, 38, is a Jesuit High School graduate who went off to Stanford, launched two tech companies in Silicon Valley and then decided he wanted to come home. He and his partners have young families and were looking for a less-expensive place to live and work. Sacramento allows them to remain close to the Bay Area and its pipeline of investors.

The city offered a $100,000 forgivable loan and Rhombus rented space in an office building owned by the Kings adjacent to Golden 1 Center. Rhombus even built its first generation of security cameras in Sacramento, in a co-founder’s garage.

“All the stars kind of aligned,” Larsson said recently. “We felt like there was a good buzz here.”

He said he thinks the buzz can last a good while. As long as Rhombus can beat the competition, it will do just fine when the recession comes. “Usually a recession doesn’t take out the successful stars,” he said.

The problem is, though, Sacramento doesn’t have enough companies like Rhombus.

Broome, whose Economic Council helped recruit Larsson and his partners, wants to build a cluster of tech companies that are founded in Sacramento and will plant deep roots in the community. He’s banking heavily on individual companies like Rhombus and the development of Aggie Square — a technology campus to be built by the city of Sacramento and UC Davis near Oak Park — to add a new pillar in the region’s economy.

Those types of businesses can “insulate us from a heavy downturn,” Broome said.

The building blocks are in place, including an increasingly well-educated workforce, a higher national profile and a feistier attitude compared to years past, he said. About 25,000 people a year are moving to the region from the Bay Area, according to census data, and Broome said “we’re getting technologists, we’re getting engineers.”

However, he said, many of those transplants still are commuting, or telecommuting, back to the Bay Area for work. That’s evidence that Sacramento hasn’t created nearly enough companies of its own, he said.

“We’ve actually made real progress ... but we’re changing too slowly,” he said. “We’re still dependent on government, still dependent upon housing, still dependent upon construction.”

Another mainstay of Sacramento’s economy — health care — could be headed for trouble.

The industry weathered the last recession with barely a sneeze; Sutter Medical Center’s $800 million expansion in downtown Sacramento was one of the few bright spots in the area economy after the 2008 meltdown.

Now, though, the industry is facing the Trump administration’s attempts to undermine the Affordable Care Act, which added millions of Californians to private insurance and Medi-Cal and increased the demand for health care services. That could take a bite out of an industry that employs 144,000 Sacramentans. (State government employs 89,000.)

“We are concerned about any dismantling of the Affordable Care Act,” said Carmela Coyle, an economist and chief executive of the California Hospital Association. “It’s just taking one of the strongest engines ... and damaging that.”

Boom and bust

California’s economy is given to wide mood swings. Many of its signature industries, including tech and biotech, tend to expand quickly when times are good and contract quickly when the economy goes south. An index compiled by national economics consultant Moody’s Analytics says employment in California is 37 percent more volatile than the U.S. average.

Consider the last two recessions. The implosion of the dot-com industry eviscerated the Bay Area economy and triggered the 2001 recession. California unemployment jumped to 6.9 percent. Nationally, the unemployment rate never got above 6.3 percent.

A similar dynamic unfolded when the housing bubble collapsed in 2008. California was one of the epicenters for flimsy mortgage loans, and home prices doubled in five years. When the crash came, the statewide unemployment rate hit 12.3 percent. Nationally, it topped out at 10 percent.

The structure of state government can amplify California’s economic instability — and ramp up the pain in Sacramento when things go south.

California’s budget depends heavily on personal income taxes — especially payments made by the wealthiest individuals. In 2015, the last year for which figures were available, just 70,000 taxpayers earning at least $1 million a year paid 40 percent of all the personal income taxes in the state, according to Franchise Tax Board data.

Because of stock market holdings and other investments, wealthy taxpayers’ incomes usually vary greatly from year to year, more than folks in the middle class. That point was painfully driven home during the Great Recession.

In fiscal 2008-09, personal income tax payments in California dropped by $14 billion (when adjusted for inflation) — a plunge of nearly 23 percent. Along with the decline in sales and corporate taxes and increases in recession-driven Medi-Cal spending for the poor, the state was quickly $30 billion in the red.

The effect on Sacramento was disastrous. Former Gov. Arnold Schwarzenegger made most state workers take two unpaid furlough days a month. He later expanded the order to three days and said they should be taken on Fridays — the birth of the infamous Furlough Fridays.

Local restaurants and retailers suffered. A Sacramento Bee analysis showed that Furlough Fridays erased more than $500 million in annual wages from the region’s economy. Combined with the woes in real estate and the private sector, unemployment in the city rose to a peak of 12.8 percent.

Income tax increases championed by Brown helped vanquish the budget deficits but may have put California at greater risk during the next downturn. The tax hikes, approved by voters in 2012, raised billions in revenue but made the state even more reliant on wealthy earners, said Ann Hollingshead, a fiscal specialist in the Legislative Analyst’s Office, in a report earlier this year. The increases landed squarely on those making at least $250,000 a year.

Brown’s administration said revenues haven’t necessarily become more volatile because of the tax changes. But its chief economist said it’s clear that the budget will suffer.

“We think a moderate-sized recession, somewhere between 2001 and what happened in 2008, will mean a $20 billion (annual) impact on revenue,” Asmundson said. The actual deficit would probably be smaller because of the rainy day fund, she added.

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