Thursday, December 16, 2004

No Bubble Trouble

by

One good thing you can say about the pundits who keep predicting that the end is near for rising home prices: They're consistent. They've been dead wrong year after year.

Despite their near certainty that the market would cool in 2004, median U.S. home prices rose 9%, and a vast majority of cities saw a bigger increase than in 2003. In fact, the National Association of Realtors proclaimed 2004 the hottest U.S. home-sales market in history. Says Thomas Kunz, CEO of Century 21 Real Estate: "There's been no rhyme or reason to prices because of multiple offers and bidding wars."

And those who fear that we're in a fragile real estate bubble can relax -- at least for now. David Seiders, chief economist for the National Association of Home Builders, speaks for most chastened housing-market analysts when he says that the chance that median home prices will drop is "zero nationally, zero in major regions and close to zero in any state," although some individual cities may see declines.

All the economic cards but one point to another strapping year for housing prices. Demand for new homes continues to be strong, driven by both first-time home buyers and people like Melani and Coates Lear, who are trading up from their Denver bungalow to a built-to-order house in a suburban development. In addition, a stronger economy, a stronger job market and higher incomes are the positives, says Seiders. He predicts the only moderating force will be modestly higher interest rates. (By "modestly higher," he means a rise from the current 5.8% to 7% for a 30-year fixed-rate mortgage.)

Most housing-market analysts now say they expect the median price increase to cool to the 5%-to-6% range nationally in 2005. Then again, that's the range they predicted for 2004. A cooling-off would also mean that houses stay on the market longer before they're sold, giving buyers more negotiating leverage.

Despite what you might think about soaring prices in your neighborhood -- or the neighborhood you'd like to live in -- investment strategist Ed Yardeni of Oak Associates says home prices aren't outrageous given the low interest rates. "You'd find out if this is a bubble if mortgage rates rose two, three or four percentage points." He predicts that would result in a loud pop, followed by falling prices. But Yardeni doesn't foresee such a hike in rates, and expects single-digit percentage increases in prices for the next three or four years.

Population boom

The demand that's driving the U.S. housing market comes from many sources. The country's population is increasing by about three million people -- or one million households -- annually, according to John McIlwain, of the Urban Land Institute. And it's no surprise that most of the growth is on the coasts, in so-called gate-way cities that see high rates of immigration, global trade and direct foreign investment (Chicago is also considered a gateway). Not coincidentally, gateway cities have also seen some of the biggest increases in home prices.

Other demographic trends are fueling this demand. Minorities, especially Hispanics, are buying in record numbers. The echo-boomer generation -- born between 1977 and 1994 and 72 million strong -- are beginning to enter the home-buying market. And don't dismiss their baby-boomer parents. Coldwell Banker Real Estate CEO Jim Gillespie points out that the youngest baby-boomers, in their early forties, are buying up, and the oldest, nearing 60, are in their prime earning years and also buying up or buying second homes.

Meanwhile, on the supply side, developers and builders in the nation's hottest markets are hemmed in on one side by an ocean and on the other by the high cost of land and by land-use constraints. David Lereah, chief economist for the National Association of Realtors, says that builders still haven't loosened up since being burned by the real estate recession of 1990-91.

About one-fourth of the nation's 316 largest metropolitan areas enjoyed double-digit price appreciation in 2004, with most in California, Nevada, the Northeast Corridor (traditionally from Washington, D.C., to Boston, but now stretching to Portland, Maine) and Florida. Except for Honolulu, nine of the ten cities with the highest median home prices are in northern or southern California. San Francisco, arguably the hottest housing market over the past decade, has the highest median price ($629,005). For a more detailed look at housing markets, see the table on page 69.

Trade-offs

As many buyers, especially first-timers, continue to be forced to the far suburbs, at least they're no longer sentenced to cookie-cutter gulags. Case in point: The Lears of Denver loved their urban lifestyle and their first home, a 1907 bungalow in central Denver. But when son Dawson arrived in August, the couple figured that their perfect little house would soon feel, well, little. Moving to a larger home in their current neighborhood, where a house big enough for a family of four runs $600,000 to $700,000, wasn't an option.

Resigned to looking in the 'burbs, the Lears cast their eyes east to Stapleton, five miles from downtown Denver, where the former Denver International Airport is being turned into the country's biggest planned community. Such developments are among the major trends shaping home building today. The couple has committed to a 2,000-square-foot home, with a base price of $360,000, that will be finished by the end of this summer.

Anticipation has replaced resignation. "Stapleton offers a lot of things that we liked about living in the city," says Coates, 35. A neighborhood park and pool within several blocks of their house are planned. A town center will feature restaurants and service providers, such as drugstores and dry cleaners. Best of all, the community has lots of other young families, with "strollers everywhere," says Melani, 31.

The best developers and builders now provide homes with a sense of place and community because that's what sells. Prairie Crossing, 40 miles northwest of Chicago, is another good example. Built on a former farm, with homes tightly clustered to preserve open space, the community is served by two commuter-rail lines into Chicago. Gary Mitchiner, 48, and his wife Ellen Winick, 43, moved to Prairie Crossing in 1996, having previously lived in downtown Chicago. They say the community is an ideal place to raise their two children. "We have more house and more community for the money in Prairie Crossing. It's a joy to wake up every morning and look out at 100 acres of open land," says Gary.

Still, heaven to some is boondocks hell to others. So a second major trend in home building is driving builders to scour the inner suburbs and downtown for land and properties that can be developed or redeveloped for residential use. Homes in these areas are typically pricey because land and development costs exceed those of green-field development farther out.

In Seattle, the Cottage Company builds "pocket neighborhoods," which consist of bungalow-style houses of less than 1,000 square feet built around a common garden. Partner Linda Pruitt says that their homes, which are typically priced in the high $300s, mainly attract single people and couples who sacrifice a large lot (and tons of yard work) for smaller, newer, high-quality homes.

Downtowns in Atlanta, San Diego, Kansas City and Milwaukee are returning to life as young professionals and empty-nesters move back for the urban scene. Nationwide, the condos and co-op apartments going up are roomy, loftlike spaces that are pricey and loaded with amenities. Condos set a new sales record in 2004 -- one million sold, versus 898,000 in 2003 -- and the median condo price hit $197,000. That's an 18% increase over the year before.

Sun Je Gray, 29, and her husband Dennis, 34, moved to Kansas City's River Market neighborhood two years ago with the idea of "being close by to things," such as the bustling farmers market, to which they can walk. Their loft-style apartment, which cost $270,000, has just under 1,500 square feet and a 300-square-foot balcony that has views of the Missouri River and the city. "If we have a child, we would probably want a house with a backyard," says Sun Je. "But that's in the future."

--Research: Katy Marquardt

HOME PRICES
Coasts up the most

Cities on the West and East coasts continued to rack up the biggest price gains in 2004. And the high prices along the coasts are pushing development inward, expanding California's Inland Empire and pushing up prices there, according to data prepared for Kiplinger's by consulting firm Global Insight.

In Sacramento, for example, median home prices rose 17%, and both the Riverside-San Bernardino area and Fresno saw 23% increases. A similar, though less extreme, trend is happening on the East Coast, as prices rise in places such as Glens Falls, N.Y. (10%), Albany-Schenectady, N.Y. (11%), and Allentown, Pa. (10%).

Las Vegas -- a.k.a. "the state of Las Vegas" -- posted gains in home values of 23%, up from 9% in 2003. Described as "the bulldozer convention of the world," the city is expected to lead the nation in new-home construction starting in 2005. Phoenix led the Southwest (excluding Vegas), with a 17% rise.

Growth in Georgia continues at a blistering pace, with 20 of the 100 fastest-growing counties, based on housing starts, according to the U.S. Census Bureau. For the past 13 years, Atlanta has led homebuilding in the U.S., according to the National Association of Home Builders, and the city remains affordable, with a median home price of $166,222 and price appreciation of just 4.4% in 2004.

Although experts expected prices in many Florida cities to cool in 2004, Fort Lauderdale and West Palm Beach ignored the prognosticators and rose 18% and 19%, respectively.

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