Sunday, December 26, 2004

Home prices full of hot air?

Many experts expect the area market to weaken with rising mortgage rates, limited income growth

By Andrew LePage -- Sacramento Bee Staff Writer


Amid a normally slower holiday season, capital region home sales continue to show surprising strength in all price ranges:

* A 2,000-square-foot Carmichael home sold in three days with three offers above the $539,000 asking price.

* A 3,300-square-foot east Sacramento home priced at $800,000 also sold in three days, with three offers and a winning bid of more than $850,000.

* A 4,000-square-foot house near American River College sold in 12 days for the nearly $1.4 million asking price.

The housing market is on pace for record sales and possibly record appreciation this year - with prices up 20 to 30 percent from a year ago.

Yet most experts predict a weaker market lies ahead. Even some of the most bullish real estate sales veterans - for whom it's always "a great time to buy" - expect slower sales and price appreciation in 2005.

Most housing analysts and economists assume mortgage rates will rise amid economic growth and inflation concerns. Higher rates sap housing demand because fewer would-be buyers can afford a home.

"There's only one wild card (for housing) next year for this region, and that's what's going to happen to interest rates," said economist Robert Fountain, a professor emeritus at California State University, Sacramento.

Mortgage rates still average less than 6 percent for a fixed-rate 30-year loan, but even economists who see little threat of a rate spike argue prices are so high relative to incomes that the market must cool soon.

There are signs that more first-time buyers either have been priced out of the market or simply refuse to chase escalating prices. Sacramento County's median resale price rose to $319,000 last month, up 29 percent from a year ago.

The estimated percentage of homes sold to first-time buyers in the county plummeted to a record low 20 percent in November, down from 40 percent a year ago and 60 percent two years ago. The trend is similar across the region, according to estimates of first-time buyer activity by DataQuick Information Systems.

Affordability is not the only factor. Experts say many prospective buyers purchased homes last year when mortgage rates hit generational lows, and a weak rental market with modest rent hikes is reducing pressure for tenants to buy.

"It might look more attractive to some people to remain renters," said Michael Carney, director of the Northern and Southern California Real Estate Research Councils. "I think a lot of people are waiting out home prices - they're not at all sure about what will happen and whether prices will fall again."

Some first-time buyers also might be getting nudged out of the housing market by investors who outbid them, a trend many view as a threat to market stability.

Investors buying homes to rent or to sell in hopes of a quick profit represented nearly one of five buyers in Sacramento County this year, according to DataQuick. The San Diego-based firm identified purchases in which the property tax bill would be sent to a different address, indicating the buyer is an investor.

The nearly 20 percent of buyers who appear to be investors compares with a decade's average of about 14 percent in Sacramento County.

"Much of what's going on in the housing market isn't being driven by housing and demographics - it's the investment market," Fountain said. "People looked at the stock market and their 401(k) and said, 'Any money I can get, I'm putting down on a house and getting a 5.5 percent mortgage on it.' "

Some housing analysts warn that if something halts investor buying - a spike in mortgage rates, better gains in the stock market or a sharp decline in rents - a big chunk of housing demand could dry up quickly. It could slow appreciation or even help send prices lower.

Another threat to housing demand is the innovative, but risky, financing that more buyers are using, such as interest-only, adjustable-rate or stated-income loans (in which no lender verification of income is necessary).

Rising interest rates or a sharp increase in defaults could cause lenders to limit such loans, leaving fewer people able to afford today's home prices.

Many economists and housing experts say if price appreciation continues to defy underlying "fundamentals," such as income and job growth, they'll be more inclined to buy into the notion of a price bubble. One common definition of a "housing bubble" is a situation in which prices rise not because of improvements in fundamentals but because people keep buying because they think prices will only go higher.

Annual growth in employment and incomes pales next to the double-digit price and sales gains in housing. Job growth in the area encompassing Sacramento, Placer and El Dorado counties was 0.1 percent in November compared with a year ago, state employment estimates show. Personal income - including wages, salaries, benefits and investments - is expected to rise 5.7 percent statewide this year, up from a 3.6 percent gain in 2003, according to a Wells Fargo economic forecast. Similar income data wasn't available for Sacramento.

G.U. Krueger, chief economist at Institutional Housing Partners, an Irvine-based real estate investment firm, said he doesn't think of Sacramento as being in a price bubble today. But he'll be concerned if the market doesn't simmer down soon.

"If you have the kind of steep curve in home-price appreciation that you had this year continue much longer, there's the risk of some kind of pricing correction," Krueger said.

The work of one national housing analyst, Ingo Winzer, deems Sacramento home prices 50 percent "overvalued" - for people with average incomes here - in a widely publicized national ranking that says Sacramento places 11th among 43 overpriced regions.

Winzer said history suggests the most likely scenario here is that price appreciation will eventually slow and then flatten for several years or more as incomes catch up with home prices.

A sudden decline in Sacramento housing prices isn't likely, he said.

"The real estate markets are entirely different than stock markets, where you could lose 20 percent of the value in a year," Winzer said.

A decline of 5 percent a year over about five years is about as much as he's seen home prices fall in a U.S. market. The heavy losses in defense jobs here in the 1990s helped spur a five-year housing slump; prices dropped about 20 percent over that period.

Winzer said prices don't sink like a rock because only owners forced to sell, perhaps due to a job loss, give in to lower prices.

Most experts agree that home prices have almost always fallen in concert with heavy regional job losses and an exodus of workers. While today's local job growth is anemic, economists don't predict big losses, either, and the region continues to attract a steady flow of retirees, super-commuters who work in the Bay Area, telecommuters and an array of consultants and others not picked up in local payroll surveys.

"Based on what I'm seeing in the market today, and the pent-up demand and the little inventory we have, I think we're going to have an another exceptional year," predicts Carlos Kozlowski, a Coldwell Banker agent in Sacramento. "I don't think we're going to have 20 percent appreciation, but I don't think it will be 5 percent, either."

Local builders have insisted for years that the main reason home prices have soared - and the reason they're unlikely to fall - is that government and environmental restrictions have made it impossible for them to keep up with demand for years. New capital region home prices have jumped about 40 percent in two years.

It now takes an average of 2.6 years for a capital region subdivision to wind its way through the planning process, according to Hanley Wood Market Intelligence in Sacramento. That's longer than in most Western housing markets, including the Bay Area, Southern California, Las Vegas and Phoenix.



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