A home-equity `meltdown' is unlikely for many reasons

Nation's Housing

May 05, 2002|By Kenneth Harney | Kenneth Harney,SPECIAL TO THE SUN

Do you ever look at the prodigious price tags on houses for sale and ask yourself: Hasn't this gotten out of control? Aren't home real estate costs completely out of sync with families' economic capacities to pay for them?

Could the long-anticipated "correction" in home value appreciation after the boom years of the 1990s turn into a meltdown?

Good questions, particularly given the pivotal role home equity plays in the net wealth and retirement planning of most owners. But before you gird yourself for the meltdown, consider a couple of perhaps surprising economic facts:

Despite the seeming disconnect between spiraling housing prices and an economy just now emerging from recession, homebuyers' incomes actually have kept pace with home prices. In fact, according to new data prepared by Standard & Poor's chief economist, David Wyss, the prices of both new and resale homes relative to household disposable income are actually lower today than they were two decades ago.

Back then, the average new home cost 3.1 times the average household's annual disposable income. Today's prices average about 2.6 times an average household's annual disposable income. In 1988-1989, according to Wyss' study, the affordability gap hit its widest point in recent years, with new-home prices averaging nearly 3.5 times average household disposable income.

The pattern has been the same with resale home prices. They're lower today relative to household income than they were in 1981. Throughout the go-go 1990s, household income growth kept steady pace with housing price increases.

The key to rapid household income growth has been the rise of the multiple-earner household. Whereas in the 1960s and 1970s the predominant home-buying unit was a single-earner traditional household, today's buyers are far more heavily weighted toward double-earner households. They bring far bigger bucks to the home-buying table.

"Ozzie and Harriet just aren't today's homebuyers," said Wyss. If they were, with mom tending the kids and dad bringing home one salary check, their disposable incomes would be lower and today's prices would not be supportable.

Mortgage costs today eat up a smaller proportion of household income than a decade ago. Lower rates expand the maximum loan amounts buyers can afford, and give a corresponding upward push to maximum sale prices.

According to Michael Carliner, staff vice president for economics at the National Association of Home Builders, the monthly principal and interest costs associated with the median-priced resale home today represent 16 percent of household income. Ten years ago that figure was 20 percent, and in 1988 it was 23 percent.

As the old real estate maxim goes, financing creates value. Low-cost financing - 30-year fixed rates below 7 percent vs. 10 percent-plus as recently as 1990 - allows buyers to afford higher-priced homes. (Just for historical review, average 30-year mortgage rates hit 16.6 percent in 1981 and only dropped below 12 percent in 1986. From 1979 through 1989, American homebuyers paid interest rates above 10.3 percent.)

An often-overlooked component of today's seemingly high prices has been the remodeling boom of the 1990s. Low interest rates have allowed homeowners to improve what they've got - pumping $100 billion-plus per year into gourmet kitchens, family rooms, media rooms and added square footage.

Resale houses in many markets with high appreciation rates are simply bigger, higher-quality and higher-amenity than they were just five years ago. So naturally they sell for a lot more. They're worth more.

Federal tax policy - radically liberalized for homeowners in 1997 - has played a major, though as yet unmeasured, economic role in pushing up home prices.

By turning primary residences into the only widely accessible legal vehicle for Americans to accumulate substantial capital free of taxes, the federal government has helped stimulate real estate hyperinflation.

Under post-1997 tax rules, your best shot at the brass ring - the maximum $500,000 tax-free exclusion on home sale gains - is by buying a higher-cost home, even if you have to stretch. A $500,000 house that doubles to $1 million gets you $500,000 tax free. But a $250,000 house that doubles in the same time period gets you "just" $250,000. The tax code bias is strongly to the upside.

And what do happy home sellers do with their big tax-free winnings once they leave the table? They put some or all of it into the purchase of their next home, often at a higher price than the last. They also spend some of it on consumer goods.

Federal Reserve Chairman Alan Greenspan doesn't see a home-equity meltdown as long as two-earner families keep bringing home the bacon.

Kenneth R. Harney is a syndicated columnist. Send letters in care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071. Or e-mail him at kenharney@aol.com.

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