Sunday, January 23, 2005

Will U.K. trend spread to the U.S.?

By John F. Wasik, Ventura County Star
A recent decline in U.K. home prices may be a harbinger for still-hot markets in the United States.

What's more important than the possible spreading of this trend is how it's developing, a pattern worth watching closely if you are investing in any torrid residential market.

The U.K. slowdown is marked by a drop in mortgage approvals, which dipped to a four-year low in November, according to the British Banker's Association. Mortgage applications declined because interest rates rose and home values eroded. The synergy of both events likely has quelled housing purchase demand.

"There is little to suggest that mortgage applications will change in the near term, given the noticeable slowdown in the housing market," stated David Dooks, director of statistics at the banker's association.

While U.S. Federal Reserve Chairman Alan Greenspan and most U.S. real estate industry groups deny the existence of a housing bubble, there's evidence that some markets are overheated.

Bubble-prone areas

A Jan. 12 report by Michael Youngblood, managing director of asset-backed securities research for the investment banker and broker Friedman, Billings and Ramsey, identified bubbles in 27 U.S. cities covering almost 20 percent of the U.S. population using third-quarter figures from last year.

The bubble-prone metropolitan areas included Boston, New York, Los Angeles, San Francisco, San Diego and Riverside. In Youngblood's study, 20 of the likely bubbles were in California.

Youngblood defines bubbles by measuring the ratio of median home prices to per capita income in each city, then taking the top 5 percent of those ratios.

"We do not expect the house-price bubble to burst in any city until economic activity has contracted for a minimum of four quarters," Youngblood stated. "The economic expansion under way generally and individually in the 27 cities that are experiencing bubbles postpones the deflation of home prices."

Overheated markets often recede when investors en masse sense that returns won't be effortless or automatic. Higher financing costs typically damp demand and cool housing values. While it's too soon to say if a bubble is bursting -- bringing about 20 percent price declines or more -- it's worth watching.

U.K. decline

In the United Kingdom, for example, home prices fell in December for the second time in three months, according to the Nationwide Building Society, a major mortgage lender.

Will the feverish U.S. market, which may see mortgage-rate jumps because of continued Federal Reserve Bank rate increases and inflation, follow the British trend?

New home sales fell 12 percent in November, according to the U.S. Commerce Department, the biggest decline in more than a decade. While existing home sales rose 2.7 percent in the month, mortgage applications fell in the week ending Jan. 7, after dropping 10.6 percent in the previous week, reports the Mortgage Bankers Association of America.

Another way of gauging home-price movements is to measure the risk of large declines in specific markets. In other words, high local volatility may telegraph a greater likelihood of a housing dip.

Francis Parisi and Scott Mason of Standard & Poor's, the financial research company, have developed a housing volatility index that tracks several major U.S. markets. They examine current home prices and mortgage rates to see where residential markets may be headed.

The markets that Parisi and Mason predict will "likely to suffer declines over the next two to three years in the event of an economic downturn" based on U.S. housing data through the second quarter are a who's who list of sizzling U.S. markets: Los Angeles, San Luis Obispo, Orange County, Santa Rosa and Ventura; Brockton, Barnstable, and New Bedford, Mass.; Fort Pierce and Miami, Fla.; Nassau-Suffolk, N.Y.; and Monmouth-Ocean and Jersey City, N.J.

If home prices plunge in any market, there will be widespread reverberations.

The fallout

Because of the wealth effect, a stagnant or falling housing market may signal to consumers to curtail spending. When consumers feel flush they tend to spend more in the larger economy, including buying more real estate. Should the trend reverse, it would curb spending.

Abiding by that theory, a large retrenchment in home prices would also hobble national economies. A July 2004 Goldman Sachs report on housing prices in the second quarter of that year titled "House Prices: A Threat to Global Economy or Part of the Necessary Rebalancing?" gave some estimates of what a housing price pullback would mean.

"If prices overshoot (are overvalued) in line with past experience and (mortgage) rates rise by 1 percentage point, the total impact (decline) on consumption in the U.S., U.K. and Australia would be 2.4 percent, 1.9 percent and 3.1 percent, respectively," the report summarized.

Word of caution

It's notoriously difficult to predict when any housing market will turn. If you're investing now, it will help to have a long-term focus of more than five years.

For short-term investors, it would be useful to watch consumer spending and income figures in tandem with mortgage applications, paying special attention to sharp drops in personal income and job growth.

Other local indicators of a slowdown are properties staying on the market for several months and sellers not getting their asking prices.

The conventional wisdom tends to focus on mortgage rates and home sales, though the psychology of the market may be a more important indicator.

Unfortunately there's no reliable index for mass home-buying mood swings. For that, you'll have to keep an eye on selling conditions in specific areas. While non-U.S. residential trends may be significant, like politics, all real estate is still a local matter.