How Bad Will the 2007 Property Market Be?

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Texas didn't experience dramatic price appreciation until more recently. Consequently, the Dallas and Houston metro areas are expected to have 2007 price increases of 4% and 3.3%, respectively.

Since trends in housing starts echo price movement, it goes without saying that new home construction is headed for a major slump in 2007. Nationally, total housing starts will slide 13.2% to 1.576 million, according to the National Association of Home Builders (NAHB) in Washington. The last time the nation saw a downturn of this magnitude was in 1991, when starts dropped 15% year-over-year.

"It isn't as bad, but it's a very big decline, and one of the big reasons is because of all the investors and speculators," says Gopal Ahluwalia, vice-president of research at the NAHB. In the fourth quarter, the seasonally adjusted annual rate will pick up to 1.635 million. At this point, the surplus in inventory will be gone, and prices will start to stabilize, Ahluwalia adds.

Looking for Value

As with prices and sales, trends in new home construction can vary dramatically from market to market. Housing starts in the Detroit area will be among the lowest in the country in 2007, plummeting 18.3% due to continuing economic woes. Interestingly, prices will not decline, but this is largely because they cannot go any lower. Seattle is the only area that will see a rise (4.7%) in housing starts, primarily because of a strong job market with companies like Microsoft (MSFT) and Boeing (BA) based in the area.

Ironically, even record-low new home construction numbers can be interpreted as good news for the overall housing market. With fewer homes being built, the market will be forced to absorb its current oversupply, bringing about the supply-demand balance that, once again, leads to more realistic prices.

"It's important to note that the value of homes isn't dropping," says Santo Rizzo, chief executive officer of Rizzo Realty Group, a Chicago-based national real estate investment firm.

The normalizing market is causing "unnecessary fear" and creating a favorable market for real estate investors, says Rizzo, who recommends investing for the long term in 2007 "losers" Orlando, Phoenix, and Las Vegas for their stable economies, high resale marketability, vacation market statuses, low vacancy rates, and favorable price-to-income ratios.

Brighter Tomorrows?

Interest rates are, of course, the wild card here. The Mortgage Bankers Association of America expects the Federal Funds Rate—the interest rate on overnight loans between banks—to remain at 5.3% throughout 2007, with the average 30-year fixed mortgage rate climbing to 6.6%, from 6%, and the one-year adjustable mortgage rate average staying about the same at 5.8%. According to the NAR, the Fed Funds Rate will fall to 4.8% by the end of 2007, the 30-year fixed rate will hit 6.7%, and the one-year adjustable rate will decline to 5.5%.

But no matter how you spin it, interest and mortgage rates are and will remain at historically low levels. The rest of the economy isn't in terrible shape, either—the unemployment rate hovers around a relatively low 5%, and the stock market is in the midst of an encouraging rally.

"The law of supply and demand, more than anything, is going to be the driving force that keeps the market relatively 'flat,' throughout the year," says Rizzo. "Since we expect the economy to continue to improve, rents to continue to rise, interest rates to remain relatively low, and investor supplies to be absorbed, the 2007 'flat' market will set the stage for brighter predictions in 2008."

So while 2007 won't be an outstanding year for real estate, it's unlikely to go down in history as one of the worst. At the very least, it will create an investment opportunity—and a great lesson in basic economics.

Click here to see how home prices, sales, housing starts, and mortgages in the largest metro areas in the U.S. will be affected in 2007.

Roney is Real Estate writer for BusinessWeek.com.