Harvard Predicts Continuing House Price Appreciation
Rising interest rates and cooling demand from speculators are bringing the nation’s housing boom to an end, but there are scant signs of any bust on the horizon, according to this year’s “State of the Nation’s Housing” report from the Joint Center for Housing Studies of Harvard University.
And on the heels of a five-year stretch of unprecedented home price appreciation, the report finds, prices are likely to continue going up, just not at a torrid pace, which will continue to draw healthy numbers of new home buyers to the marketplace.
Looking at another potential trouble spot — the growing popularity of exotic new mortgage instruments designed to enable buyers to squeeze into increasingly expensive housing with lower monthly payments — the report finds that when the payments on these loans do rise, the majority of borrowers won’t find themselves in dire financial straits.
While all bets are off if the economy should suddenly stall out and start losing jobs or if heavy overbuilding occurred, neither of these preconditions for a housing bust is in evidence, according to the Joint Center, and the industry slowdown now in play appears headed for a soft landing.
Cooling Investor Demand
“The greatest threat to housing markets is a precipitous drop in house prices,” the report says. “Fortunately, sharp declines of 5% or more seldom occur in the absence of severe overbuilding, dramatic employment losses or a combination of the two.”
Rising mortgage interest rates are responsible for much of the blame for the current slowdown in sales. From January of 2005 to January of this year, there was a 1.56 percentage-point increase in adjustable mortgage rates and a 0.44% increase in fixed mortgage rates, which has helped push up inventories of both new and existing homes for sale. Even so, as of this March, the supply had yet to reach the six-month level that defines a buyer’s market, although there was a 6.9-month supply of condominiums.
A rise in the number of homes for sale and the amount of time it takes to sell them should cool investor demand, the study says, with repercussions for the disposition of the homes they recently bought.
The investment share of home loans climbed into the 9%-10% range in 2004 and 2005, compared to 6%-7% for the 1999-2003 period. In most of the top 50 metro markets for investors and second home buyers, the investor share more than doubled between 2000 and 2005, according to the report. Among the markets with the highest share of investors are several metros in Florida and California, as well as Boise, Idaho; Phoenix; and Las Vegas.
If the departure of investors from the housing market does materialize — a process that already appears to be starting — “it will be at least a year before it is clear how quickly these investment properties can be sold to owners who intend to use them as primary or second homes,” the Joint Center says. “In the hottest markets, the overhang of investor properties may be absorbed rapidly if housing production continues to fall. The recent sharp increase in vacant single-family homes for rent suggests, however, that this process will not be smooth.”
Milder Price Corrections Than in the Past
There is also likely to be a bit of a wait for nominal price declines to materialize: “When and if house prices do fall, the so-called bubble is more likely to deflate slowly rather than burst suddenly. History suggests that appreciation eases for a year or two before prices come down in nominal terms. While dips of a few percentage points are common, nominal house prices rarely drop by 10% or more.”
Declines of 5% or more in nominal house prices have occurred at least once over the past 30 years in roughly half of the nation’s largest 75 metro areas, almost always because of significant job losses or overbuilding. “In terms of magnitude, price declines associated with episodes of major job losses alone average 4.5%, while those occurring in and around periods of overbuilding alone average 8.3%.”
The Harvard study points out that the amount and duration of joblessness were less in the 2001 downturn than in previous recessions, and that building activity since has been much less intense than in periods prior to drops in housing prices.
“In metros experiencing major house price declines in the past, three-year average development levels exceed the 20-year median by about 74%,” the study says. “In 2001-2004, development in these same metros was only 10% above normal. These signs of moderation provide good reason to believe that the next house price correction will be milder than in the past.”
The study notes that even with the national homeownership rate nudging down a tenth of a percent last year, it increased in the West and Northeast, where home price appreciation has been the strongest. About 1 million home owners were added in 2005, and for many of them, mortgage innovations such as low-downpayment, hybrid-adjustable and interest-only loans helped blunt the impact of higher home prices and interest rates.
Interest-only loans went from obscurity two years ago to an estimated 20% of the dollar volume of all loans and 37% of all adjustable-rate loans originated in 2005, according to Harvard. Payment option loans — which let borrowers make minimum payments that are lower than the interest due on the loan and roll the balance into the amount owned — accounted for nearly 10% of last year’s loan originations. About 3 million borrowers have interest-only adjustables and 1 million have payment-option first mortgages.
While monthly payments can be driven up sharply at the end of the agreed-upon period, “most interest-only loans extend for at least five years, leaving ample time to move, refinance or incomes to grow before principal payments start coming due,” said Nicolas P. Retsinas, director of the Joint Center.
Home owners who find themselves unable to make their mortgage payments also have more than a small measure of protection in the equity they have accumulated. In 2004, before the latest price surge last year, only 3% of home owners had equity of less than 5% and 87% had a cushion of at least 20%, the study said.
Stretching to Buy Homes
Deteriorating affordability represents the downside to the housing boom that is now fading. Between 2000 and 2005, home price increases were six times greater than increases in household incomes. “As a result, the median house price exceeded the median household income by at least four times in a record 49 of 145 metro areas, and by more than six times in 14 metros.
The markets in the country where the median price of an existing single-family home last year was the highest compared to local median income were:
- Los Angeles-Long Beach-Santa Ana, Calif., where the median home price was 12.7 times the median income
- San Diego-Carlsbad-San Marcos, Calif., 10.3 times
- San Francisco-Oakland-Fremont, Calif., 10.3
- San Jose-Sunnyvale-Santa Clara, Calif., 9.1
- Honolulu, 8.3
- Miami-Fort Lauderdale-Miami Beach, Fla., 7.7
- New York-Northern New Jeresey-Long Island, 7.5
- Riverside-San Bernardino-Ontario, Calif., 7.4
- Sarasota-Bradenton-Venice, Fla., 7.3
- Barnstable Town, Mass., 7.2