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Real Estate Analysts Find Scant Housing Bubble Evidence
Scrutinizing the imputed cost of owning a single-family house compared to renting the same unit in 46 metropolitan areas over the past 25 years, a paper prepared for the current fall issue of the Journal of Economic Perspectives concludes that there was little evidence of a housing bubble at the end of last year.
The recent rapid growth in prices has been caused by supply and demand rather than by “home buyers who are willing to pay inflated prices for houses today because they expect unrealistically high housing appreciation in the future,” according to the authors of the study — Charles Himmelberg, senior economist, Research and Statistics Group, Federal Reserve Bank of New York; Christopher Mayer, Paul Milstein professor of real estate, Columbia Business School, Columbia University; and Todd Sinai, associate professor of real estate, The Wharton School, University of Pennsylvania.
“In high-appreciation markets like San Francisco, Boston and New York, current housing prices are not cheap, but our calculations do not reveal large price increases in excess of fundamentals,” the economists say. “For such cities, expectations of outsized capital gains appear to play, at best, a very small role in single-family house prices.”
Instead, the authors of the report, “Assessing High House Prices: Bubbles, Fundamentals and Misperceptions,” attribute recent “rampant” price increases in housing to basic economic factors such as low real, long-term interest rates; high income growth; and housing price levels that had fallen to unusually low levels during the mid-1990s.
From 1995 to 2004, real prices of single-family homes in the U.S. grew at an average annual rate of 3.6%, or nearly 40%, the analysts report, compared to an average annual rate of 0.5% between 1975 and 1995, or 10% over the course of two decades.
Housing prices overall looked “reasonable” last year, the study says, and appeared to be overvalued in only a few cities — Miami; Fort Lauderdale, Fla.; Portland, Ore.; and to a degree, San Diego.
“Our evidence does not suggest that house prices cannot fall in the future if fundamental factors change,” the report says.
“An unexpected rise in real interest rates that raises housing costs, or a negative shock to a local economy, would lower housing demand, slowing the growth of housing prices, and possibly even leading to a house price decline. However, this fact does not mean that today houses are systematically mispriced.”
Interest-Rate Sensitivity
Because real long-term interest rates have been so low, the economists point out that housing costs currently are more sensitive to an increase in those rates than at any other time in the past 25 years.
The article cites previous research presenting evidence that there are certain “superstar” cities — such as San Francisco, Boston, New York and Los Angeles — where tight supply constraints (such as land and government regulation) combined with an increasing number of people who want to live in the area, can produce higher-than-average house price growth over an extended period. In these cities, house prices will be higher relative to rents and more sensitive to changes in interest rates.
Lower mortgage origination costs have made it easier for home owners to refinance their mortgages to enjoy the benefits of lower interest rates; may have permanently increased the demand for housing; and may have lowered the imputed rent associated with owning a house for more recent home buyers, the report says.
However, the study cites a number of statistics indicating that it is, at the very least, an oversimplification to conclude that home prices have surged recently because it has become easier to borrow:
- While average mortgage amounts have grown much faster than inflation or incomes, growing from more than $120,000 since 1995 to a record high of more than $261,000 in 2003, average downpayment amounts have been climbing even faster. The average first mortgage in 2003 had a downpayment of more than 25% of the house value, nearly five percentage points higher than in 1995.
- Downpayment percentages are the highest (and loan-to-value ratios the lowest) in the most expensive cities: averaging 39% and 34% respectively for buyers in San Francisco and New York. “We suspect that this occurs in part because existing home owners use large capital gains to put more money down on their next house.”
- While home buyers in high-priced cities are more likely to take out adjustable rate mortgages, which make borrowers more vulnerable to increases in interest rates, the use of these loans fell disproportionately in the country’s most expensive cities, with declines from 1995-2003 of 21% and 16% in San Francisco and New York, respectively. From 2001-2003, ARMs made up less than 20% of all new mortgages, a rate lower than all but one year in the 1990s, before rising to 34% in 2004.
The economists caution that their research does not extend to conditions in the condominium market, “which due to its lower transaction costs and higher liquidity may be more vulnerable to overvaluation and overbuilding arising from investor speculation.”
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