From file "023_pss" entitled "PWbubble.qxd" page 01
From file "023_pss" entitled "PWbubble.qxd" page 01

The median price of a home on Long Island, N.Y., rose by 13 percent in June to $429,000. That same month, Newsday reported, the number of unsold homes on the island increased 22 percent to 19,120 units. Therein lies one of many contradictions that define the current housing boom, which has been on an unprecedented roll for more than a decade. Most experts expect market prices to eventually subside moderately, but some industry watchers fear that this sector is in for a more precipitous fall that could have national economic implications. A blizzard of opinions and statistics has emerged in recent months to support both claims.

There's no dispute that prices have gone through the roof and that owners have gotten richer. During this latest boom, homeowners'net worth (on paper, at least) has ballooned some $3 trillion, says David Lereah, chief economist for the National Association of Realtors (NAR). And prices are still rising in many markets, especially in California, where fewer than one in nine households could afford a median-priced home, with a price tag in June that exceeded $522,000. Nationwide, prices rose, on average, 12.5 percent during the year ending March 2005, according to an index calculated by the Office of Federal Housing Enterprise Oversight. The Federal Deposit Insurance Corp. (FDIC) found that, over the past three years, 55 markets had inflation-adjusted price appreciation of 30 percent or more.

Prices in some markets have been pumped up artificially by speculators "flipping" homes for profit within a few months of their purchase. LoanPerformance, which tracks monthly mortgage activity, estimates that "investors" accounted for nearly 10 percent of the market in the first quarter of this year, versus 6 percent in 2001. NAR sees an even greater speculative presence when it estimates that 23 percent of homes purchased in 2004 were bought for investment and another 13 percent were purchased as second homes. In response, builders in several states now include "anti-speculation" clauses in their contracts, which stipulate that homes being purchased must be owner-occupied for at least a year, or buyers pay extra, as much as $70,000 in some cases.

Of greater concern has been the FDIC's finding that, in 38 of 50 states, income growth hasn't kept pace with home price escalation. Consequently, buyers are turning in greater numbers to mortgage instruments that require little or no down payments and are far more flexible in their equity terms and payout schedules. Adjustable-rate mortgages accounted for 46 percent of new mortgages and 37 percent of applications last year, versus 29 percent and 19 percent, respectively, in 2003. Sub-prime loans rose to 20 percent of the total in 2004, up from 9 percent in 2003. And nearly one-third of all new mortgages in the first six months of 2005 called for interest-only payments (in California, it's almost half), according to LoanPerformance. The irony is that 30-year fixed-rate mortgages may actually be a better deal now. "People are paying as much as 50 basis points more [for these alternatives], which is a sign of desperation," says Michael Carliner, senior economist with the NAHB.

Market bears like Morgan Stanley's chief economist Stephen Roach disparage the current boom as a house of cards whose day of reckoning has only been postponed by "a mountain of debt" taken on by buyers through negative amortization mortgages that are propped up by foreign investment capital. (The New York Times reported in June that foreign investors hold $4.6 trillion in mortgage-backed securities, more than the total value of U.S. Treasuries.)

The Other Side of the Coin Yet a sizable contingent of economists, analysts, and builders remains convinced that unless interest rates rise significantly or an international "event" occurs that disrupts the national economy, the housing "bubble" will deflate, if at all, moderately and regionally, as it has done historically. The FDIC notes that between 1978 and 1998 there were, in various markets, 54 booms and 21 busts (when nominal prices fell at least 15 percent over a five-year period). This suggests that most booms settle into periods of regional price stagnation rather than spiral into national disasters.

That's not to say, though, that some markets aren't more vulnerable to price deflation. Lereah of NAR–which projects that home sales this year will increase 2.8 percent to 6.97 million units–told The Wall Street Journal in July, "You can't sustain double-digit price appreciation and keep homes affordable." Credit Suisse First Boston's housing analyst, Ivy Zelman, speaks for many of her colleagues when she sees a "bubblish" market, especially in coastal areas where development is constrained by environmental or zoning restrictions.

Some economists say that today's boom will simply conform to prevailing market fundamentals. Mark Vitner, senior economist for Wachovia's Economics Group, explains that over the past two decades the U.S. population increased by 57 million people, three-quarters of whom reside in the 15 states under the greatest price appreciation pressure. Vitner also notes that "there's absolutely no supply out there," and estimates that of the 440,000 homes on the market nationwide in April 2005, 22.7 percent hadn't been completed and 20 percent hadn't been started. Two Federal Reserve of New York economists, Jonathan McCarthy and Richard Peach, wrote last December that between 1990 and 2003 American families gained 130 percent in purchasing power due to deep interest-rate cuts and a 50 percent jolt in median household incomes.

How the current housing boom plays out over the next several months is still anyone's guess. Builders say they are already see a leveling off of price appreciation in overheated markets like San Diego, where home prices in May rose by 7.5 percent, the first time in six years that market's prices increased by only single digits. Other industry watchers also think some markets–such as Miami, where an estimated 18,565 condominiums will be added this year alone–have finally gotten too far ahead of reasonable demand expectations.

But wild speculative construction that marked past booms and busts in New England and California appears to be a thing of the past. "We all thought we were infallible, but for 15 years I've managed my business with the mind-set that a recession could be around the corner," says Larry Webb, CEO of Newport Beach, Calif.–based John Laing Homes. "I don't want to make the same mistakes again."

–John Caulfield is a contributing editor for PROSALES.