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Hot Markets Raise Some Housing Bubble Concerns
 Housing market analysts at last week’s NAHB Construction Forecast Conference in Washington, D.C. who are attempting to assess prospects for a collapse in housing prices in some of the nation’s most overheated markets are having a tough time reaching any firm conclusions.
They did, however, find cause for concern over the sustainability of the boom that is occurring largely in parts of the East and West Coasts and worrisome indications that lower-end buyers have been disproportionately taking out adjustable-rate mortgages that expose them to interest rate risks they may not be able to handle.
Speakers at the conference also emphasized that the conditions that prevail in areas that are now seeing unhealthy levels of purchases by investors and speculators are not unique and are similar to those occurring at the end of the housing cycle in the late 1980s.
“Home sales activity has easily been hitting records,” said NAHB Chief Economist David Seiders. “Just basically it’s been wow — up, up and away.”
Seiders said that he had been hoping to see some slowdown in housing price appreciation by the start of this year, but preliminary indications suggested that prices have continued to rise at a double-digit gallop in the first quarter. The Office of Federal Housing Enterprise Oversight (OFHEO) reported that prices advanced at an annual rate of more than 10% in last year’s second half.
On the positive side, “home owners have been enjoying strong real rates of gain,” Seiders said. Also, it would take an economic downturn to precipitate local home price declines, and, at least nationally, there does not appear to be a recession on the horizon. If the economic expansion continues long enough, rising mortgage interest rates could have a settling effect on overly frothy markets, avoiding a plunge into post-boom doldrums.
“The key part of a bubble is that people buy an asset solely because they think it is going to go up in the short term,” said Thomas Lawler, senior vice president for risk policy at Fannie Mae. There was no evidence of that in housing until a year ago, he said.
Last year, housing price growth exceeded household income growth and overall inflation by more than at any time since the 1970s, he said. Even so, housing has remained relatively affordable nationwide, at the same time as affordability in certain boom markets has receded to the lowest levels since the 1980s.
Lawler said that the investor share of prime conventional conforming purchase loans has increased dramatically since 1990, reaching 11.5% at the end of last year, and that is an understatement of investors’ participation in the housing market because not all of them take out loans and their activity tends to be underreported.
The areas that have been the hottest, with the fastest rising prices, tend to be those that have seen the biggest increases in investment share, he said. That includes Las Vegas, and San Francisco, Santa Barbara and Orange County in California. Examples of cities where the investment share is below the national average include Akron and Cleveland, Ohio; Birmingham, Ala.; and Buffalo, N.Y.
Citing another indication that the potential for a housing bubble may have intensified, “home sales have dramatically exceeded household growth,” Lawler said. “Home sales have just absolutely exploded and it’s hard to find an explanation in the demographics.” Also, Census data suggest that the single-family rental vacancy rate has gone up sharply.
Conditions in the mortgage market also suggest vulnerability in pricey housing markets where buyers have had to resort to adjustable-rate mortgages and non-traditional financing and lenders in order to qualify for their purchases at a time when the cost of fixed-rate financing has been historically low.
In the recent period, “the share of fixed-rate mortgages has been flat to down,” Lawler said, “and the ARMs share has been very high when it should be low.”
One area of special concern on the financing scene, Lawler indicated, is a shift of sub-prime borrowers away from FHA mortgages to adjustable-rate loans. There were $600 billion in sub-prime originations last year, he said, and the vast majority of them — 66% — were in two-year ARMs.
Two-thirds of sub-prime mortgages — which go to borrowers with lower credit scores, less history managing money and less stable incomes — will be reset between now and 2006, he said. “If the Fed stopped raising interest rates today, the vast majority of these loans go up 200 basis points.”
“No one can say that a ‘bubble’ exists until after the fact,” Lawler said. “However, conditions in many parts of the country, though certainly not most of the country, mirror past conditions that preceded regional housing ‘busts.’”
Based on early findings from NAHB surveys being conducted in 25-30 hot metro areas among builders of all sizes, Seiders said that the investment share appears to be higher in condominiums than single-family housing and is perceived as more of a problem by bigger builders than smaller builders.
Builders surveyed by NAHB in hot markets reported that 11% of their single-family home sales in hot markets have gone to investors, compared to 15% of condo sales. About 92% of the investors in single-family homes and condos have been individuals, and only 2% are foreign buyers.
The investor shares reported by high-production builders were relatively low — 3% and 10% in single-family and condo markets, respectively — and 40% of the big builders said they offer financing to investors through their own financial subsidiaries. But the terms for investors are not the same as for other purchasers: 67% of the builders said they charge investors higher interest rates; 67% use stiffer underwriting standards; and 33% require higher downpayments.
Seiders said that many builders, particularly big ones, are actively taking steps to limit investors, such as including in their contracts a clause giving the builder the right to buy back a home at its original selling price if it is sold within a year.
Photo by Morris Semiatin
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