Despite prices through roof, homes still affordable to many

Nation's Housing

September 12, 2004|By KENNETH HARNEY

FOR ANYBODY who tracks home appreciation rates, the latest federal numbers are stunning and sobering:

The average home in the United States gained 9.4 percent in market value from mid-2003 to mid-2004. That average increase is more than three times the rate of inflation for goods and services in the economy overall during the same period, as measured by the Consumer Price Index.

Maryland's 15.4 percent increase during the 12 months that ended in June was the sixth-highest in the nation behind Nevada, 23 percent; Hawaii, 19 percent; California, 18.4 percent; Rhode Island, 17.9 percent; and the District of Columbia, 16.1 percent.

Average gains in a record 74 metropolitan housing markets, including Baltimore, were in double digits for those 12 months. The Baltimore area posted a 15.61 percent increase. Ten markets recorded price gains exceeding 20 percent, topped by Las Vegas, where the average increase was like a casino jackpot at 25 percent.

No metropolitan housing market experienced net losses in average home values last year, and in only two states - Texas and Utah - was the average housing appreciation rate less than the 3.03 percent rise in the Consumer Price Index.

Some regions, especially the South, Midwest and mountain states, posted gains of 4 percent to 6 percent, less than the national average. But those regions traditionally have been less volatile than the high-cost West and East Coast markets.

If you are a homeowner or prospective buyer, what do you make of this latest data?

Everybody loves to hear that his or her home is worth more than it was a year earlier. But how long can prices keep surging before houses become too rich to afford and the home appreciation party comes to a jolting, sobering end?

The average selling price of a house in Washington, D.C., has risen 95.1 percent in the past five years, according to the Office of Federal Housing Enterprise Oversight, the agency that monitors home appreciation every quarter. Yet average household incomes in the nation's capital haven't doubled since 1999. The same is true in Rhode Island, where home values have jumped 88 percent in five years, California (up 84 percent) and Massachusetts (up by 74 percent.)

How can buyers afford to keep paying these inflated prices, and where are the usual cyclical restraints that cool down overheated pricing environments? There are a couple of factors at work here.

To begin with, many of the metropolitan markets with the biggest gains have strong employment bases, below-average rates of unemployment and household incomes far above the national average. Repeat buyers in these areas tend to have substantial equity positions that they can move tax-free to new purchases, even at significantly inflated prices.

Then there is the essential ingredient powering high housing inflation nationwide - the low cost of money and its impact on demand. Thirty-year mortgage interest rates hit a four-decade low of 5.23 percent in June last year, hovered between 5.6 percent and 5.7 range early this year, then slipped back to 5.45 percent in the spring. Extended periods with interest rates of less than 6 percent are virtually unprecedented in modern American mortgage history, and there are no signs of a sudden rise.

Lower-cost mortgage money enables homebuyers to afford larger mortgages and pay higher prices for homes without a corresponding increase in income. That converts pent-up demand into effective demand - home sales - at every rung of the price ladder.

David Lereah, the chief economist for the National Association of Realtors, says the key to the equation is not simply low interest rates but also low household debt-service ratios. This means the ratio of regular monthly debt obligations - mortgages, credit card payments, auto loans and so on - to gross monthly household income.

In the early 1980s, according to Lereah's research, typical household debt ratios exceeded 30 percent. That is, a family's total debt-service payments ate up 30 percent or more of household income each month. During the late 1980s and early 1990s, ratios dropped to about 22 percent. Average household debt service ratios are now 17 percent to 17.5 percent.

Lereah says home sales and price appreciation slow whenever debt-service ratios exceed 22 percent but don't begin to drop significantly until the ratios exceed 30 percent. By his calculations, it would take 30-year mortgage rates of 8.5 percent or higher to push household debt-service ratios to that level again.

That hardly means that near-record average appreciation is here to stay for the long term. Most economists agree that interest rates are likely to rise over the coming year or longer. Given that consensus, figure on more moderate gains in value in the months ahead. The appreciation party won't be over, but the noise level will go down a notch or two.

Ken Harney's e-mail address is

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