Sunday, April 10, 2005

Let's Get Real About Real Estate

"People have gotten caught up in the euphoria" of a stellar housing market, says Steve Murray, editor of Real Trends, an industry newsletter, who forecasts rates will reach 7% by year end. "Everywhere you go people are talking about how much their homes appreciated," he says. "We are going to have to be a little more rational the next few years." Mr. Murray predicts that if mortgage rates reach 7.5%, the number of units sold will drop 8% to 10%.



By KELLY K. SPORS
Staff Reporter of THE WALL STREET JOURNAL
April 10, 2005

Spring is typically when people focus even more on buying and selling homes. But proceed with caution: Real estate has become a higher-stakes game than "Celebrity Poker."

Skeptics will tell you that the "red-hot" housing market seems ripe for a cool down. Their argument: Rates on 30-year fixed mortgages, which crept over 6% in recent weeks, will reach at least 6.5% by year end, as many economists predict. That's still low by historical standards, but may be a drag on home sales and begin to flatten out prices in many regions.

On the other side of the table, though, are housing-market bulls who point out that such dire predictions have been off the mark before. There's really no such thing as a "housing bubble," they insist, because real-estate prices can't tumble on a flurry of panic selling, as happens when a stock-market bubble bursts. After all, everyone needs a place to live.

"Stocks have a single market, low transaction costs and the capability of people to pile on nationally," Robert Curran, senior director at Fitch Ratings, wrote in a recent report. "Housing markets are all local. Transaction costs are large. To sell your assets you have to move."

Bubble or not, it's risky right now to sell or buy a house, especially if you make a move that is a roll of the dice on the direction of home prices. Some coastal markets with particularly rapid price increases in the past few years could see prices drop in coming months, while other areas could continue to see prices go higher.

Here are some considerations to minimize your risks:

Who Should Worry

Not everyone needs to get overly worked up about a slower housing market. Homeowners who stay in the same house through the down years will probably come out all right. Sure, homes may not appreciate as quickly -- or at all -- for a while. Nobody likes that.

The harshest effects will be felt by those who buy a home just as prices are peaking and then sell during a downturn. Also, homeowners with adjustable-rate mortgages, or ARMs, could get stung by higher monthly payments as rates rise and the homes become less affordable. About one-third of all mortgage loans taken out in February were adjustable.

[Back to Earth?]

If prices fall or flatten out, it takes longer to recoup the expenses and transaction fees of buying the home. Most housing experts suggest it takes five to seven years to make sure a home will beat out renting -- and that's particularly true during a lousy housing market. Those who are forced to sell during a downturn could ultimately lose money.

Even flat prices can hurt buyers. While many buyers have been making money on their homes in less than a year or two, it often takes several years -- five or more -- for buying a home to make sense. That's especially true if you get a high mortgage rate.

The "rent vs. buy" calculator at Dinkytown.net9 helps explain this. For instance, if you buy a $300,000 home with a 7% mortgage rate that appreciates 2% a year, it would take about eight years for you to beat out renting for $1,500 a month. If that home appreciates 8% a year, it would take only 2½ years, according to the calculator.

"When people think about buying a house, the overriding issue should be where do they want to live and for how long," says Chris Mayer, director of the Milstein Center for Real Estate at Columbia University. "If they're going to live in it for seven years, buying is going to override renting in every part of the country."

Remember, housing markets differ from region to region. Some markets such as Indianapolis and Austin, Texas, saw only single-digit annual price increases the past few years and are less vulnerable to flat prices or huge declines.

Moreover, high-demand coastal markets such as San Francisco and Boston will be more vulnerable to price drops because prices have shot up so quickly. Nevertheless, markets already struggling due to unemployment or other regional woes could feel the added pinch of higher rates. Nationwide, prices grew 11% in 2004, but the pace of price increases has started to decelerate in recent months, according to the Office of Federal Housing Enterprise Oversight.

What to Expect

Even in housing's worst years, prices rarely collapse. They usually level off for a while or fall modestly. "Housing booms end with a whimper, not a bang," says Karl Case, an economics professor at Wellesley College. He suggests looking at history. When the housing market dried up in 1990, prices in Boston fell 15% after a long run-up. And that was an extreme case. Less-volatile markets saw prices level off before rising again.

Here's how it usually plays out: Rising rates spark less demand for homes because they're less affordable. The demand shortage leads to an oversupply of houses up for sale. Many sellers, in turn, are forced to either lower their asking prices or pull their homes off the market. They often decide not to sell if they don't have to.

There is some concern, however, about an increase in speculators buying up homes in particularly hot markets like Las Vegas. If speculators -- those gobbling up homes as hot investments and not as residences -- succeed in driving prices too high in a particular market, the chances go up that home prices could take a tumble.

The Bigger Picture

Factors other than rising mortgage rates affect the housing market. There are several positive economic trends that could help soften any blow that interest rates make. For one thing, the recent cycle was propelled partly by a wave of immigrants buying their first home in the U.S. Also, the baby boomers poured money into homes and most are still in their prime earning years. Land shortages also are keeping demand high in many coastal markets.

Ultimately, Mr. Mayer says people shouldn't fret too much about drops in housing prices, unless there is "an appreciable downturn in the economy" or another major terrorist attack. "Then we need to worry," he says.

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