Thursday, November 18, 2004

2005 Housing Market Forecast: Mostly Sunny, Partly Cloudy

by Broderick Perkins, Realty Times

A barometric pressure reading of the air surrounding the housing market would reveal dense levels of uncertainty.

The housing market, especially the second and vacation home sector, is poised for yet more growth, but it could also crumble under the pressure of higher interest rates that push over-leveraged homeowners into the poor house.

The nation's housing market received a mixed forecast from the Urban Land Institute's annual Emerging Trends In Real EstateĀ® 2005: "The Race Is On Between Improving Fundamentals and Rising Interest Rates," a study now in it's 26th year.

The study, co-produced by PricewaterhouseCoopers LLP, provides an outlook for real estate capital markets with forecasts for a host of realty sectors, including commercial, retail, office, apartment, research and development, hotel and others.
This year, for the first time, the study provides a detailed outlook for the residential sector.

After enjoying more than a decade of growth, the study says, the housing market faces uncertainty in the face of rising interest rates, a sluggish economy and weak job and income growth.

"Can real estate supply/demand fundamentals improve enough in 2005 and 2006 to offset the potential negative impact of rising interest rates on property values and pricing? Make no mistake, the race is on," says the report.

"For 2005, it all comes back to interest rates, the economy and job growth."

Emerging Trends first tracks the success of the residential real estate market, fueled by low interest rates that have driven the home ownership rate to an unprecedented 70 percent. The demand has spurred record levels of new home developments springing "out of the ground like weeds wherever builders can muster entitlements."

The study says homeowners in the past decade have enjoyed not just a roof over their heads, but an investment yielding spectacular returns far beyond those from stock market portfolios, retirement funds and other investments.

In many cases, homeowners have helped fertilize industry growth by plowing their earnings right back into real estate, buying home improvements and second homes to keep them and their investments well sheltered.

A proven cornerstone of the nation's economic foundation, housing also has helped keep the retail sector sailing while many other real estate sectors floundered, the report says.

Homeowners use "their homes as giant ATMs."

Unfortunately, right now, indicators point to a market at a cyclical peak.

Analysts who contributed to the report say, at the very least, rising rates will knock some young buyers out of the market. Prices will adjust as interest rates go up, they say. Over-leveraged homeowners will suffer most. While it won't be a bloodbath, losers will surface.

More optimistic analysts say interest rates won't rise quickly and that will sustain the housing market, which remains the most promising sector in all of real estate.

Infill development and the reverse flight from the suburbs back into downtowns remain trends with growing popularity. Other home buyers are willing to pay premiums for smart growth planning going into master planned suburban and new urbanist communities, the report says.

Based on the residential real estate market's strengths and weaknesses, Emerging Trends also provided the following prognosis for the residential real estate market.

* Interest rates are key. As long as rates remain affordable, Americans will continue to buy starter homes, they will move up to bigger quarters and they will purchase second homes as vacation, retirement and investment properties.

Real estate remains "Americans' number-one investment asset and almost a national imperative."

* First-time buyers who used no- to low-down payment mortgages, bargain basement adjustable-rate mortgages and mortgages with interest-only payments, who are also stretched to the limit on car payments and other household bills, are most at risk. Higher health care, energy and interest rate costs, combined with flattening wage gains and slow job growth could wipe them out. If first-timers are hit hard, the starter home industry could likewise feel the pinch -- if only temporarily.

* Affluent baby boomers are less vulnerable. Many of them have already diversified into the second home market and take with them time-honored lessons in frugality. They've been snatching up smaller, less-expensive homes nearer urban and resort centers at such a pace many of the areas have become exclusive enclaves where the locals have difficulty buying. Baby boomers will also pad their equity with income from the new lite-work lifestyles of today's aging Americans who put off retirement or take the part-time work route.

* The housing market appears to be in a solid supply/demand balance and most study analysts do not expect mortgage rates to advance enough to stop buyers from buying and builders from building. Again, it all hinges on the cost to buy and build.

"Interest rates will tell the story. If they rise too far too fast, the bubble deflates," the report says.

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