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House Prices: More Down-to-Earth?


Since spring of last year, the U.S. dipped into recession, suffered terrorist attacks, and watched as the stock market sputtered. Against that backdrop, the median price for single-family houses climbed 7.1% nationally between last April and this, according to the National Association of Realtors (NAR). In some markets, the gains were astounding: Los Angeles, up almost 18% since March a year ago; Washington, 20%; New York, 21%; and Providence, R.I., 19%.

House prices have become either a horror story or a cause for celebration--depending on whether you're buying or selling. The relentless escalation stalled only momentarily after September 11. The numbers marched higher again in the first quarter of this year.

Even San Francisco--where prices rocketed 40% between 1999 and 2001 and then fell as the nation's woes combined with the region's dot-com sorrows--has taken off again, say local real estate agents such as Joseph Koman. One of his clients, Tom Murphy, a journalist who lost his job in the dot-com shakeout, got six offers for his four-bedroom Victorian house this April. The turn-of-the-century home went for $66,000 more than its $549,000 asking price.

Such runups trounce what investors have seen in the stock market lately--a fact that escapes no one. Murphy owned a weekend house as well. As his tech stocks soared in the late 1990s, he wondered whether he should have so much money tied up in real estate. "Now I'm glad I did," he says.

But can the gains continue? Or are those pouring money into home and hearth in for the same disappointment suffered by tech investors?

First, note that the truly outsize gains have come in only a handful of markets--mostly metropolitan areas in the Northeast and in California. The 7.1% increase from last April to this was a lot better than the measly 2% gain in family income during the same time and the 1.6% inflation rate. Housing prices can diverge from income and inflation trends, but generally not for long.

The runup doesn't seem so shocking, considering that the average annual gain since 1968 has been 6.3%, according to the NAR, and the recent leap came as mortgage rates dipped to their lowest since the late 1960s. Then, too, many argue that the NAR's numbers exaggerate gains since they don't adjust for the fact that houses are now larger, and therefore pricier. Even at today's prices, houses are more affordable than a decade ago, in light of interest rates and incomes, according to NAR's index.

At least they are nationwide. Few economists argue that housing prices are heading for a crash. More likely is a slowing in the annual increase--to perhaps 3% to 4% for the next 12 to 18 months--as interest rates nudge higher and prices take a breather to allow incomes to catch up.

But anyone who lived through the 1991 recession knows that real estate can plunge in specific markets--and that declines tend to come in the very places that run up most in the boom years. Los Angeles saw prices drop 21% between 1991 and 1996. New York and Boston dipped, too. Ingo Winzer, president of The Local Market Monitor, which analyzes real estate in about 100 markets, cites San Francisco and San Jose as two areas in danger of a fall. Real estate in both is overpriced, based on the historic ratio of local income to price, vs. the nation as a whole, he says, and each has lost jobs. The same could be said for New York. Job losses eventually lead to more home sales and outward migration, increasing supply and pushing prices down.

Add Boston to the watch list, says Kenneth Rosen, chairman of the Fisher Center for Real Estate at the University of California at Berkeley's Haas School of Business. But he thinks prices will probably just grow more slowly unless the economy drops back into recession and mortgage rates, currently about 6.8%, move above 8%. If both happen, prices in such areas could plummet 10% to 15%, Rosen says. Otherwise, real estate tends to correct by stagnating or rising slowly after quick runups.

Why did prices jump so much in the first place? Low interest rates, for starters. But demographics and a more accommodating mortgage industry may be as important. A flood of immigrants entered the country beginning in the late 1980s and became established enough to start buying houses just as baby boomers headed toward their peak home-owning years, says David Berson, chief economist at Fannie Mae. Home ownership rises with age and is actually highest among the 65-plus crowd.

At the same time, mortgage lenders, sensitive to complaints that minorities were being locked out of home ownership, eased up on credit terms. Fannie Mae now accepts mortgages where borrowers put nothing down as long as they pay an amount equal to 3% of the loan in the form of closing costs. Compare that with the 10% and 20% downpayments of the late '80s. The rule limiting mortgage payments to no more than 28% of gross monthly income has also fallen away. Fannie Mae tells lenders to ignore that old standby ratio and focus instead on the applicant's credit history and the loan-to-home-value ratio.

As money became easier to borrow, people had more of it, too. Family incomes rose 44% in the '90s. And some investors pulled cash out of the stock market to buy homes. The result: a bigger percentage of a bigger group all wanting to buy homes. Home ownership in the U.S. soared to an historic high of 67.8% last year, up from 65.7% in 1997.

Supply couldn't always grow to accommodate this increased demand. Regions such as San Francisco and the New York suburbs had little undeveloped land. Construction restrictions tied to concerns over sprawl or the environment often added to the squeeze. As a consequence, the supply of homes for sale dropped to just over 4 months of demand, compared with the normal 5 to 6 months. Predictably, tight supply made for a competitive market. Supply has since loosened a bit.

While near-term increases aren't expected to match the gains of the past, economists say demographics should then hold prices roughly in line with disposable-income gains during the coming decade. That's expected to be 5.5% to 6%, says Berson. Over time, prices have risen at a rate 1% above inflation, notes Doug Duncan, chief economist at the Mortgage Bankers Assn.

So, housing may be another sector, like stocks, where a downshift in thinking may be required about a likely return. But nothing has really changed. Housing will continue to be a not-so-liquid investment that promises steady returns over time. Just how much depends on your timing--and location, location, location. By Carol Marie Cropper


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