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Posted 3/29/2002
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Will your home hold its value? There's a lot of talk about home prices reaching a bubble. Fact is, there are four big reasons the doomsday scenario may not play out. By Scott McMurray From homebuilders out West to home sellers on Manhattan’s Upper West Side, spring is bustin’ out all over:
Hold the champagne, homeowners. Doesn’t this have all the earmarks of a bubble that wants to burst? Won’t rising interest rates choke off home buying? (The national rate on a 30-year mortgage is a bit over 7% -- and higher than a year ago -- and may hit 7.5% by year's end.) Aren’t we consumers in way too much debt and in no position to take on more? Let’s slow down. First, it’s possible overall activity will soften a little from 2001 and certainly from current levels. In fact, James Glassman, senior U.S. economist at J.P. Morgan Chase, expects housing starts will dip a modest 5% or so this year. His reasoning: A mild winter across much of the country in 2001 led some builders to proceed with projects that they might have waited to start this year. Existing home sales will probably drop back from current levels, but there’s almost no way 2002 won’t be a strong year. Four big forces are arrayed to buoy the housing market in 2002 and for the next few years. These forces should just about offset the modest interest rate increases that many economists see coming from the Federal Reserve Board -- unless inflation takes off or economic calamity strikes: Investing begins at home A home of one’s own continues to be the largest single asset held by most Americans. Homeowners have $11 trillion invested in single-family homes, according to Fannie Mae, the big buyer of mortgages from lenders. While that’s roughly equal to the $11 trillion U.S. households had invested in stocks, bonds and mutual funds as of mid-2001, the fact is home ownership is far more broadly based than stock ownership. The wealthiest 20% of households hold nearly half the securities. Indeed, a National Association of Realtors survey of homeowners from last fall (prior to Sept. 11, in fact) found that the equity we have in our homes outweighed the value of our investment portfolios, on average, by a ratio of 3-to-1. With stock prices still volatile and the major index averages still well below the all-time highs reached in early 2000, many families remain focused on preserving and protecting the equity in their homes. The collapse in mortgage rates in 2001 to 7% or lower -- rates not seen since the 1970s -- sparked a home refinancing boom of unprecedented proportions. (It also pushed new and existing home sales to record levels.) According to Fannie Mae, the nation’s largest buyer of home mortgages, Americans plowed an estimated $50 billion of home equity refinancing money back into the U.S. economy last year, often for fix-up and other housing-related expenses. That was a key reason the economy proved so resilient. We’re NOT carrying too much debt Economic Cassandras caution that what helped the economy last year will come back to haunt it this year. With the rush of refinancing behind us, consumer debt is not only greater, but many of us won’t have the cash to pump into the economy this year to keep the recovery going. Maybe, but these facts don’t seem to be enough by themselves to sink the economy, or home prices. Take consumer debt. The debt-to-income ratio for consumers hit a record 22.3% last December, Federal Reserve data show. But historically this barometer tends to rise during periods of low inflation, and correspondingly low interest rates, so the interest cost becomes more affordable for many consumers, notes columnist Gene Epstein in the March 18 issue of Barron’s. A more telling ratio is debt payments to disposable personal income, says Epstein. Here the news is better. By the third quarter of 2001, the latest figures available from the Fed, households were spending 7.7 cents out of each after-tax dollar to pay off debts. That’s a penny lower than the peak of 8.7 cents reached in 1980 when the prime rate hit a killer 21.5%. Moreover, the ratio has been growing at just 0.1 cents per year since 1996, when consumer spending started on a tear as the economy expanded. In other words, households may have more flexibility before serious problems erupt. Yet another step on the statistical scales for the American consumers: they’re being more careful. While 47% of Americans who didn’t pay off their credit card balances in February made only the minimum payments, according to a survey by the Cambridge Consumer Credit Index, Americans on the whole were taking on slightly less debt in March than they were in February. The economy is ready for a rebound The manufacturing sector, which slumped under the weight of excess inventories for much of last year, is lean and hungry. The February purchasing managers’ index published by the Institute for Supply Management jumped to 54.7 from 49.9 in January -- the first time in 19 months that the index had registered above 50. That indicates that the manufacturers are expanding again, and manufacturers tend to expand output before they add jobs and boost wages. That would bode well for housing, as more workers could afford homeownership, and others would be interested in trading up to more expensive homes. So, could the economy heat up so quickly that inflation erupts and drives interest rates higher? Possibly. Yet, there still seems to be enough concern among corporate CEOs about their companies’ growth prospects that a red-hot, manufacturing-led rebound doesn’t seem likely. And inflation, unless exaggerated, usually translates first into higher existing home prices before it pushes rates high enough to choke off demand badly. Many economists believe rates would have to go substantially above 8% to really hurt real estate. Demographics add an underpinning The domestic population is growing. Families are having babies, and immigration is adding a powerful buying force to many real estate markets. In fact, the immigration rates in this country nearly doubled to 1.1 million a year in the 1990s, up from slightly more than 600,000 a year in the 1980s. Immigrants typically take about seven years to buy their first home, says Erik Doersching, vice president of Chicago-based housing industry consultant Tracy Cross & Associates. So even if immigration were sharply curtailed tomorrow, there would still be several years of increased buying from immigrants who arrived in the latter end of the 1990s. And many immigrants appear to be buying homes in cities and suburban areas in the Northeast and Midwest. That should support home prices in precisely the areas the baby boomers are expected to be moving out of en masse as they begin retiring over the next several years and migrate south and west. One caveat to the big national picture: Local and regional conditions can have a disproportionate impact on housing prices. Southern California and Connecticut home prices were devastated by the sharp cutbacks in defense spending in the early 1990s following the collapse of the Soviet Union. It took several years for each market to recover, though they both caught up with most markets by the end of the 1990s. Silicon Valley may recover more quickly. Following thousands of job cuts over the past two years, San Jose home prices fell 3.8% in the fourth quarter of last year, but still posted a gain of 0.62% for all of 2001. If early signs of a rebound in the high tech sector hold true over the next several months, Silicon Valley home prices may already be at or near a bottom. Indeed, some markets like Washington, D.C. and the San Francisco Bay Area overall may be close to peaking, according to a recent analysis by the Economist magazine. Whether you live in the District of Columbia, where home price gains aced all 50 states and jumped 14.94% last year, or Kansas, where home prices gained a more modest 4.98%, when it comes to most Americans' largest investment, there’s no place like home. 
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