Study: ‘Bubble’ Likely to Deflate, Not Pop

Glenn Roberts Jr., Inman News
Friday June 16, 2006



House prices surged faster than household income and inflation, the national home-ownership rate fell for the first time in over a decade, housing inventories shot up with slowing sales, and the volume of sub-prime loans has soared. 

But despite these findings, released today by Harvard University’s Joint Center for Housing, the outlook for the housing market is generally good. 

“The greatest threat to housing markets is a precipitous drop in house prices. Large house-price declines appear unlikely for now. But if the economy falters, both job growth and housing prices will come under renewed pressure. This would spark higher default rates, especially among sub-prime borrowers, and turn housing from an engine of economic growth to a drag,” according to the report, The State of the Nation’s Housing 2006. 

By 2005, house prices were rising at the fastest pace since 1978, the report states, and “media reports of a housing bubble reached a fever pitch. But, when and if house prices do fall, the so-called bubble is more likely to deflate slowly rather than burst suddenly.” 

Typically, job losses, overbuilding and population outflows are factors in home-price declines, the report states. “While dips of a few percentage points are common, nominal house prices rarely drop by 10 percent or more.” Though about half of the nation’s 75 largest metro areas have seen nominal house prices drop by 5 percent or more at least once in the past 30 years. 

Over the past several years, real estate economists have said that the strength in the housing market has served to buoy the nation’s economy. Now, the performance of the general economy will help to determine how well the housing market weathers this slowdown. “Housing’s contribution to economic growth is already diminishing and will begin to turn negative if home sales, starts, and home equity borrowing continue to decline.” 

Nicolas Retsinas, director of the Joint Center for Housing Studies, said, “We’ve turned the corner, certainly, from a seller's market to a buyer's market. The days of double-digit (price) appreciation are certainly behind us. The question before us, in this period of price correction, is, 'Will it be a flattening for the market or a more severe drop?'” 

He added, “Overall, the market is probably fairly solid, but in the short term there will be some rough patches. The wild card ... is the economy.” 

While price appreciation is slowing, Retsinas said that prices likely will not moderate enough to eliminate affordability problems. Rising energy costs have also affected housing affordability. From 2001-04, the number of households paying half of their incomes for housing increased by 1.9 million -- an estimated 15.6 million low- and middle-income households are classified as having “severe cost burdens” for housing, according to the report. And about 49 percent of poor working families with children had severe cost burdens in 2004, while 75 percent had at least moderate burdens. 

Affordable rental housing for those earning $16,000 or less each year shrank by about 13 percent from 1993 to 2003, according to the report, and “a significant portion of the remaining affordable stock is in financial stress.” 

Household growth is expected to grow from about 12.6 million over the past 10 years to 14.6 million in the next 10 years, the report states, while “widespread affordability problems will also intensify.” 

An increase in foreclosures is likely as the market transitions, Retsinas said, given that it may not be as easy for some distressed homeowners to sell their properties and avoid a foreclosure process. “If I had a problem making my mortgage payment a year ago I could put my house on the market. If I had a problem this year it might not be quite as easy. I might not have that 'escape hatch.'” 

Meanwhile, the overall home-ownership rate dipped from 69 percent in 2004 to 68.9 percent in 2005, the first drop after 12 consecutive years of gain, according to the report, as the rental market began to rebound. 

New single-family home sales increased 6.7 percent from 2004-05, while existing single-family home sales increased 3.4 percent and existing condo and co-op sales grew 9.3 percent. Median new single-family home prices grew 4.4 percent from 2004-05, existing single-family prices gained 9.4 percent, and existing condo and co-op prices rose 13.4 percent. 

“Although 2005 surpassed 2004 on many measures, housing markets were clearly moderating. Indeed, the year-over-year change in sales of existing homes turned negative late in 2005,” the report states, noting that a rise in interest rates is the likely culprit. 

Slowing sales boosted the inventory of new and existing homes to a supply of about 5.3 months to 5.5 months in March 2006. The months' supply is used to gauge how long it would take to exhaust the for-sale inventory of homes given the current sales rate. A supply of six months is considered to be roughly equilibrium between a buyer's market and a seller's market, with a shorter supply indicating a seller's market and a longer supply indicating a buyer's market. 

The inventory of condos reached a “near-term oversupply,” the report also concludes, with the supply climbing from 3.9 months to 6.9 months. 

Investor demand for real estate is expected to cool, according to the report. “In the hottest markets, the overhang of investor properties may be absorbed rapidly if housing production continues to fall. The recent sharp increase in vacant single-family homes for rent suggests, however, that this process will not be smooth.” 

Investors bought 4 percent of single-family homes built and 13 percent of condos sold, according to a June 2005 survey by the National Association of Home Builders, while investors bought an average 11 percent of new single-family homes and 15 percent of condos in the 30 large markets that posted the fastest price appreciation. 

“Among the housing markets with the highest investor loan shares are several Florida and inland California metros, as well as Boise, Phoenix and Las Vegas. In most markets, the investor share more than doubled from 2000 to 2005,” the Harvard report states. 

“I think we've reached a point where housing is no longer seen as a purchase for investment. It's something to live in,” Retsinas said. 

The volume of sub-prime loans has jumped “dramatically,” the report notes, from $210 billion in 2001 to $625 billion in 2005, with last year's sub-prime lending total representing 20 percent of the dollar value of loan originations and about 7 percent of mortgage debt outstanding. The share of sub-prime loans that were at least 60 days delinquent or in some stage of foreclosure was seven times higher than that of prime loans in fourth-quarter 2005. 

Interest-only loans, which defer principal payments for a specified number of years, “went from relative obscurity to an estimated 20 percent of the dollar value of all loans and 37 percent of adjustable-rate loans originated in 2005,” according to the center's report. “Payment-option loans, which let borrowers make minimum payments that are even lower than the interest due on the loan and roll the balance into the amount owed, accounted for nearly 10 percent of last year's loan originations.” 

Meanwhile, adjustable-rate mortgages, which doubled their share of the market to 35 percent in 2004, dropped slightly to 31 percent in 2005. 

The construction of new rental properties has slowed from 275,000 units in 2002 to 203,000 units in 2005, which—along with the conversion of some rental units to condo units—has assisted in lowering the vacancy rate from 10.2 percent in 2004 to 9.6 percent at the end of 2005.