A Squeeze On Home Prices
(Business 2.0) – Jack Torza has been selling houses for 29 years, and he's never been more optimistic. Subdivisions are going up all over his territory in Hanover, Va., a leafy suburb of Richmond. Properties usually sell in a few days, and the sales force he manages for Long & Foster Realtors just logged its fifth straight record year. For much of that run, of course, the economy stank. "If someone had told me five years ago that we were going to have five of our best years, I would've never believed him," Torza says. Now that the rebound has arrived, he reasons, nothing can hold home prices back. "This is going to be a good year," he says.
Perhaps in Torza's zip code. Nationwide, though, residential real estate's amazing run could well be over. Normally, you'd expect home prices to thrive in a strong economy, but this housing market has been anything but normal. Prices are coming off a 21 percent rise since 1998, their strongest five-year gain in history. That would be a feat in the best of circumstances; that it occurred in the face of rising unemployment was almost miraculous. But the economic recovery changes the landscape fundamentally--and, odd though it may sound, not necessarily for the better. Interest rates are now rising, not falling, and stocks once again compete as investments. To cap it off, home prices are now so high that in many places renting makes more sense than buying. "Housing is at the mountaintop," says Economy.com chief economist Mark Zandi. "From here, all roads lead down."
More than anything else, what drove home prices up during the downturn was the fall in interest rates. In a strong economy, however, rates go in the other direction, and that will hit buyers right where it hurts. If the average 30-year fixed-rate mortgage reaches 7 percent by year's end, as many economists predict, the monthly cost of a $350,000 mortgage will be $340 higher than it was last summer. That's enough to squeeze out thousands of potential buyers--and, in an already inflated market, to cause prices to fall.
In an economic rebound, homeowners can't even count on a good stock market crash to bail them out. Dean Baker, an economist with the Center for Economic and Policy Research, a Washington-based think tank, notes that the housing boom started in earnest in 1998 as growing stock portfolios gave people the confidence (and the down payments) to bid up house prices. When the crash came two years later, investors actually poured more money into real estate, seeking a haven from their collapsing brokerage accounts. "On the way up, the stock market kicked off the housing bubble," Baker says. "On the way down, it reinforced it." That repeats a pattern of the not-so-distant past: The housing boom of the late 1980s started immediately after the stock market crash of October 1987.
Zandi argues that the simultaneous collapse of mortgage rates and equities flushed into the housing market many buyers who otherwise might have waited years before buying. This creates a problem that Zandi calls "spent-up demand." Translation: Marginal buyers who would have been natural customers for housing during the next few years (as they became more financially secure) instead jumped at the opportunity to buy in 2003. That can only weaken demand in the near term, Zandi says, and as a result, "even a small rise in rates will have a huge impact." Markets in which prices have been running up faster than household income are particularly vulnerable to small hikes in mortgages. (See "Home Buyer Beware," below.)
Softness in rental prices further crimps demand. The apartment market ended 2003 with the highest vacancy rate in 15 years, in part because a lot of renters rushed to become owners. "The housing market is fueled by rising rents," explains Michael Sklarz, an economist with real estate services firm Fidelity National Financial. "It's a big catalyst for people to buy."
The good news is that these problems won't last forever. The National Association of Realtors argues that demographic trends, including surging immigration, will spur huge demand for many years to come. In the meantime, agents like Torza may be wise to soft-pedal real estate's quick-buck potential. During the next few years, your house probably won't be a great nest egg. It'll just have to do as a nest. -- PAUL SLOAN