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Over the last eight years, there has been an unprecedented run-up in home prices in several U.S. markets. Affordability is at an all-time low with only about a quarter of American households able to afford a median-priced home. Yet about 70 percent of Americans currently own their homes, arguably the highest percentage of home ownership in the population of any industrialized nation.
Nevertheless, there is cause for concern. The chart below, excerpted from a paper published in August 2003 by Dean Baker and Simone Baribeau of the Center for Economic Policy and Research, shows a sampling of the extreme price increases over the last five years:
Source: Office of Federal Housing Enterprise Oversight 2003
Baker and Baribeau note in the executive summary of their paper “Homeownership in a Bubble: The Fast Path to Poverty?” that price increases across the nation have exceeded the rate of inflation by at least 30 percent since 1995.
We do not dispute the fact that we have overheated markets on both coasts, as well as in a few inland markets. The real question is whether the inevitable correction will be a crash in housing prices or stabilization with a protracted and moderate decline of prices to sustainable levels.
We believe that in this cycle the latter will be the case. Therefore, rather than the term “bubble,” which implies a burst and collapse of prices, we prefer to describe the present state of some markets as “hyperinflated.”
In the previous cycle, price crashes did occur on both coasts. Two factors contributed to this, neither of which is present in the current cycle.
First, there was a serious oversupply of housing units by 1989. In 1990, competitive liquidation of unsold inventory by developers began, causing a sharp break in prices. Second, in 1990, the economy was moving cyclically from expansion to recession.
Faced with economic uncertainty, home buyers retreated from the marketplace, creating an oversupply of existing homes for sale. The decline in prices that continued until 1994-5 was exacerbated by the deferral of buying decisions by the home-buying public.
Oversupply is a necessary prerequisite for a price crash. That is not the case in this cycle. Builders are now pacing construction very tightly to demand. Oversupply is also being inhibited by increasing political control over development that restricts new construction in many markets around the country.
Second, the economy is not contracting, as it was 1990, but expanding. After a mid-year surge, gross domestic product growth for the fourth quarter of 2003 was a healthy 4 percent. Real personal income for 2003 was up 3.6 percent.
While we agree that investment may have superseded shelter as a primary home-buying motive in the closing months of the bear market in equities, homes do not lend themselves to speculation as do stocks. Real estate lacks the liquidity of the stock market, is not traded daily and has no futures market.
Transaction costs for homes are very high in comparison, and sales require one to three months to close. Moreover, social issues, such as attachment to one’s home, family size, and employment situations, impact both buying and selling decisions, making them highly individual. People buy and sell homes for personal reasons rather than in response to market activity.
High sales volume of new and existing homes is not dependent solely on new household formation. Increased mobility of the population is also a factor. California, dominant in the above chart, gained more than 600,000 in population in 2003 and has added more than 500,000 people each year for the last four years.
With home ownership at 70 percent, most moves mean the sale and purchase of homes. That’s not speculation. That’s meeting a need.
Finally, we believe the correction has already begun. Referring again to the chart above, note that the most recent one-year price appreciation is in nearly all cases less then the average annual increase over the last five years.
Building permits, housing starts and sales of both new and existing homes have declined slightly in recent months. We anticipate stabilization of prices and moderate declines in overheated markets over time, not a bursting bubble.
Alexis McGee is president and Alan Smith is communications director of Foreclosures.com, a distressed property investment advisory firm. The company tracks foreclosure activity and publishes pre-foreclosure property data for 18 California counties, the Phoenix, Ariz., Chicago and New York City metropolitan areas and New Jersey.
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