February 9, 2005
The debate about a housing bubble is becoming more
intense. Between World War II
and 1995, housing prices have increased in line with inflation. Since that time,
housing prices have increased 40 percent faster than inflation.
The median price of new homes sold was up more than 13 percent in the past year according to the latest report in December. Furthermore, the current unsold inventory is 4.8 months of sales, up from 4.0 months a year ago. Accelerating prices and inventory are inconsistent for any length of time in the housing market.
Some economists have noted that lower mortgage rates
have offset the higher housing prices.
As a result, about 45 percent of all households nationwide can afford
the median home (which is $188,000 when previously owned homes are
included). This is very close
to normal affordability conditions.
Furthermore, something must be right about the housing
market, as a larger percentage of households own homes (at least with the
help of their bankers) than at any time in history.
In order to get some idea of what view is correct, it
is necessary to understand what causes bubbles.
Some economists believe markets are so efficient that
bubbles do not happen anymore. However,
they were not invested in NASDAQ when that index hit 5000 in 2000.
Bubbles happen because investors chase asset prices
instead of purchasing the intrinsic value of assets.
As most people occupy the homes they buy (thus deriving an imputed
rental income from their homeownership), they derive value from their
However, a recent survey showed that more than 8
percent of all home contracts are being closed by people who do not intend
to occupy their homes as a primary residence.
This is up by nearly a third from only three years ago.
Some of these purchases are vacation properties.
With so many baby boomers nearing retirement, the number of
households owning second homes is expected to rise from the current 3
percent to more than 6 percent in the next decade.
Certainly some of that rise in home contracts for other than a
primary residence reflects the second home market.
Nevertheless, excesses have been observed in specific
markets. A year ago, the number
of new houses resold in Las Vegas without being occupied by their original
purchaser became so intense that builders required a payment penalty for any
home resold in less than a year. This
cooled a 53 percent annual price surge in Las Vegas homes.
Florida Gulf Coast properties; housing from
Fredericksburg, Virginia to Portland, Maine; and almost all residences in
California have been cited as exceeding reasonable price gains.
However, signs of rising unsold inventory are just beginning to
surface in those areas.
In Atlanta, the number of days that a home is offered for sale before it is either sold or withdrawn has increased sharply in recent months. However, the price received relative to asking price has hardly budged except in a few overheated in-town neighborhoods.
Furthermore, the average Atlanta household has income
that is 11 percent above the national average and is buying a home whose
price averages only about 15 percent higher than the national median.
This is excessive, but not spectacularly so.
Of course, the key is household affordability, which
changes with employment opportunities, wage growth, and mortgage rates.
Job growth is accelerating, and wage growth is drifting upward.
While mortgage rates clearly are higher than when the
fixed rate momentarily broke below 5 percent in 2003, they are not much
higher. Unfortunately, variable
rate mortgages are rising with every Federal Reserve meeting, but fixed
rates actually are drifting downward.
Many homebuyers reach for more house than they can
afford by using the normally lower variable rates to qualify for their
loans. As those rates rise,
home affordability is beginning to decline.
No economist sees home affordability plunging, but few see home
prices continuing to outstrip inflation either in the next year or so.
So, no bursting bubble, but no hot investment opportunity either in the current housing market (and that also is true for Atlanta).