Wednesday, September 08, 2004

Is the Housing Boom Over? Part 2

Is the Housing Boom Over? Part 2
Home prices have gone up for so long that people think they'll never come down. But the fundamentals tell a different story—a scary one.
By Shawn Tully

FORTUNE


And in many strong markets supply isn't constrained at all. Take condos in Miami. Today the high prices are doing just what they should, stoking a rampage in construction. Instead of shunning developers, Miami and many other cities are encouraging them to rebuild their ravaged business districts into gleaming clusters of residential and office towers. In southeast Florida no fewer than 25,000 new condo units are planned for construction or conversion in the next 18 months. "Since about 5,000 new condos sell a year, that's about five years' supply," says real estate consultant McCabe. "Miami will have an enormous oversupply of condos in a couple of years."

When prices get high enough in the hottest markets, buyers simply commute from areas where homebuilding is plentiful and prices are low. That's what's driving growth in the Inland Empire, which comprises Riverside and San Bernadino counties east of Los Angeles and north of San Diego. Houses here cost less than $300,000 on average. So thousands of people who work in Los Angeles are moving in—and spending up to two hours a day on the highway. "If you could save $10,000, it wouldn't be worth it," says Bruce Norris, an investor who has bought many houses in the area. "But when you can save $200,000, suddenly the commute doesn't hurt so much." But even relative bargain spots are not immune to competition. As prices climb in the Inland Empire, says Nick Manfredi, a local real estate investor, more commuters are choosing to rent homes in Orange County and other places closer to their jobs.

Another wellspring for supply: At these prices, retirees are starting to cash out—and moving to up-and-coming locales where it's still cheap. A case in point is Jack Cushing, 74, a veteran of the auto-leasing business in Chicago who's lived the past seven years in Las Vegas. This summer, Cushing decided to take the money and run. "This was a one-shot opportunity to make a lot of money," says Cushing. "My wife and I really liked Las Vegas. I would never have sold if the market hadn't been so strong." Cushing sold his home for $485,000, banked a tidy profit, and spent $400,000 for a home in Phoenix that's bigger—and, he says, even nicer. Look for a lot more arbitrage as the first wave of baby-boomers starts retiring in a few years.

Put all these elements together, and it's hard not to be alarmed. In the worst-case scenario, interest rates would spike, bringing the boom to a sudden end. House prices in the overheated markets would fall steeply. And the pace of sales would tumble: Owners who couldn't afford their mortgages or had to relocate would be forced to sell at a loss, but others would simply pull their homes from the market. That would have an immediate impact on the real estate sector, which accounts for about 25% of the entire economy. New construction would slow dramatically, thousands of real estate brokers would lose their jobs, and the furniture and appliance industries would go into the tank. There'd be the risk of a downward spiral, as consumers started to rein in spending, further slowing the economy—and driving home prices even lower.

Fortunately, that's still a long shot. The most likely outcome is far less dire. If job growth accelerates and mortgage rates don't climb above 8%, real estate will muddle through. Prices in places like New York, Boston, and San Francisco will simply slide sideways for three to five years, not even rising with inflation. Eventually, rents and incomes will catch up. In the rest of the country, prices will still inch upwards, giving the economy a modest lift by supporting a healthy construction market, at least in certain regions. And houses will go back to being homes and nothing more. What would be so bad about that?

Return to Part 1.