Sunday, March 20, 2005

Rising prices may hurt real estate

Experts say hot market appears to be cooling off

Knight Ridder

The U.S. housing market finally appears headed for a slowdown after four years of spectacular growth that's raised widespread fears of a real estate "bubble."

Because rising short-term interest rates and worries about inflation are driving up the price of home mortgages nationwide, home sales are expected to slow, and prices in some markets could even fall.

Economists differ over how much sales may drop. Optimists expect the growth in sales to level off from phenomenal recent peaks. Pessimists warn that many metropolitan markets may see bursts of housing "bubbles" -- markets in which speculative investment drove prices higher than usual demand can sustain -- similar to the collapse of the high-tech stock-market bubble in the late 1990s.

Although mortgage rates remain relatively low, they're rising, and that's fueling the debate. The benchmark 30-year fixed mortgage rate crept up to a seven-month high of 5.85 percent March 10, up from 5.34 percent a year earlier. The one-year adjustable-rate mortgage, popular with investors who purchase homes to resell quickly, is around 4.24 percent, up from 3.20 percent the year before.

Most experts agree that a slowdown is overdue. The Federal Reserve has raised short-term lending rates by 1.5 percentage points in six quarter-point moves since last June, but long-term rates were slow to follow until recently.

Federal Reserve Chairman Alan Greenspan has made it clear that more short-term rate hikes are coming, and higher mortgage rates are expected to follow. Freddie Mac, one of two federal housing-finance agencies, predicts a 30-year fixed mortgage rate of 6.25 percent by year's end.

That should curb the rise in home prices, which surged a spectacular 11.2 percent last year, the fastest rate since 1979, according to the Office of Federal Housing Enterprise Oversight, which is responsible for overseeing the mortgage market. Nationally, home prices have risen 8.4 percent annually over the last five years; 20 percent or more annually in high-price areas around major cities from Washington to San Francisco.

Sales of new and existing homes have broken records for four consecutive years. Yale University economist Robert Shiller said the only similar housing boom in U.S. history was when GI's returned home from World War II, lifting a depressed market. About the postwar housing precedent, he said: "It wasn't a bubble, it was a surge in real demand." He thinks the current boom is a "classic bubble" because people keep buying houses they know are too expensive because they expect prices to rise even higher.

Economists in the optimist camp think that a growing economy, and an influx of new buyers as the "echo boom" generation enters the market, will keep home prices rising, albeit more slowly. They expect mortgages to remain affordable.

"We are expecting 6.5 percent by midyear, which is low in a historical context," said Celia Chen, the director of housing economics for Economy.Com, a business consultancy. "I think for the most part we will see a soft landing nationally. We don't anticipate a decline in house prices on a national average."

Other economists take a more dour view, but stop short of predicting havoc.

"I do think it is going to weaken over the next year as interest rates go up. Owning is going to look more expensive relative to renting," predicted Jan Hatzius, a senior economist at Goldman Sachs investment bank in New York. "The key really is what happens to interest rates."

Pessimists think the nation's hottest real-estate markets are in a bubble driven by unbridled speculative investment. Anecdotal evidence abounds. Outside Washington, young professionals camp out overnight for a chance to bid on new homes. In South Florida, new homes and condos can sell two or three times before they're even built.

In late February, a National Association of Realtors report provided stunning confirmation that speculation in housing is soaring. The group said 23 percent of homes purchased last year were bought as investments or second homes. The report suggested that many people are buying homes for quick turnarounds, much as they'd plunk money into rising stocks.

On March 7, David Berson, the chief economist for Fannie Mae, the nation's largest supplier of home mortgage funds, observed in his weekly commentary that investor ownership of housing hasn't been this high since the late 1980s, which led to a crash in housing prices.

"Many analysts think that a high investor share in the Northeast and California helped exacerbate the housing downturn that happened during the 1990-1991 recession," he wrote, noting that home prices stayed depressed well beyond the recession's end.

Berson suggested it could happen again because "the risk of regional home price declines is higher" as so many purchases are by speculators rather than residents.

UNC Charlotte real estate professor Steven Ott says no.

Home prices in the Charlotte area have risen a total of 19.1 percent during the past five years, or about 3.5 percent a year, much slower than the national average of 8.4 percent a year, according to the Office of Federal Housing Enterprise Oversight.

The region is growing, Ott says, but not so fast to make the area's appreciation rates unsustainable.

"With housing bubbles, you are dealing with areas that are very constrained with respect to land and an ability to build new homes," says Ott, head of UNCC's recently formed Center for Real Estate. "I don't see any issue here at all."


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