Home prices are hot, and they aren't likely to cool off soon

Nation's Housing

March 21, 2004|By KENNETH HARNEY

HOW HOT can home values get?

The latest federal housing price survey suggests that they can get hotter than anyone predicted for an economy with scant job creation and a sluggish overall recovery.

The average home nationwide gained 8 percent in resale value from the final quarter of 2002 through the end of last year, according to the Office of Federal Housing Enterprise Oversight, which tracks resale and refinance home prices nationwide.

Houses in 14 states and the District of Columbia appreciated at double-digit rates, and 12 metropolitan markets racked up rates exceeding 15 percent.

In Maryland, prices rose 12.75 percent, the fifth-fastest pace in the nation. In Baltimore and its five surrounding counties, prices rose 13.27 percent, ranking it 27th among metropolitan areas.

On a quarterly basis, the national rate was even more surprising. The weather was cold late last year, but home values were toasty, gaining an average of 3.67 percent nationwide in the final quarter. In Maryland, prices rose 5.73 percent during the quarter.

All of this has occurred in the face of an inflation rate for goods and services in the national economy that is well below 2 percent. The core Consumer Price Index rose 1.1 percent from January 2003 to January 2004.

What is going on here? Didn't most economists agree that after four years of housing price inflation averaging 7 percent to 8 percent annually, the national home appreciation rate was certain to flutter down to about 4.5 percent, which has typified the past two decades?

They did, but most of those economists also assumed that the cost of mortgage money would rise from the record lows of mid-2003. Slightly higher rates would hold back consumers' ability to afford higher-cost homes.

Interest rates have headed south, however, during recent months. Home mortgage rates are 40 percent below where they were in the spring of 2000, when the average 30-year fixed-rate loan cost 8.5 percent.

Buyers last week could lock in 5.25 percent 30-year fixed-rate mortgages and 15-year fixed-rate loans at about 4.5 percent. Buyers willing to gamble with shorter-term adjustable-rate mortgages found rates of about 3.5 percent.

Cheap loans translate into higher selling prices because the monthly costs of homeownership are lower.

Also propelling the price boom are bedrock federal tax subsidies - billions of dollars a year that allow homeowners, but not renters, to accumulate wealth through higher home equities. Homes are by far the most tax-favored of all capital investments. You generally can write off 100 percent of your mortgage interest and local property tax payments against your federal taxes.

You can pocket $250,000 (single filers) to $500,000 (married joint filers) of capital gains tax-free as often as once every two years. As a result, you can carry your tax-free gains from one house to another, using your untaxed previous profits to afford your next house, even if the price is greatly inflated.

That's just part of the formula for housing inflation that's eight times the rise in the Consumer Price Index: Federal tax subsidies keep home real estate appreciation higher than it would be in the absence of subsidies.

Another factor, suggests Frank Nothaft, Freddie Mac's chief economist, is steadily increasing average household incomes. Though it's hard to believe if you live in a market with double-digit home appreciation, Nothaft says household incomes over the past decade have increased at about the same pace as average housing prices nationwide, 4.5 percent to 5 percent.

Still another factor contributing to higher prices in some markets, Nothaft suggests, has been tight supplies of new and previously owned homes, forcing buyers to compete for fewer units.

In other markets, tough environmental and zoning restrictions have pushed up the cost of land substantially by limiting the supply of residential lots.

How long can this merry-go-round continue? How many years of double-digit average appreciation in dozens of high-cost markets is possible? Don't prices at some point get out of alignment with local employment and income growth?

On this point economists appear to be unanimous. "This is not sustainable" indefinitely, said Patrick J. Lawler, chief economist for the Office of Federal Housing Enterprise Oversight. Today's buyers should not assume that 8 percent and higher annual gains are guaranteed - or even likely. To the contrary. Remember that housing prices can and do level off. They sometimes decline, as happened in Southern California a little more than a decade ago, when prices plunged 20 percent to 30 percent.

That's nowhere in sight nationwide, certainly not as long as the cost of mortgage money stays so low. But it's a distinct risk in a handful of high-flying markets if local employment and incomes cannot keep up with soaring house prices.

Ken Harney's e-mail address is kharney@winstarmail.com.

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