Housing comes in for a landing

December 25, 2006|By Douglas Lamdin

The remarkable rise in house prices in Baltimore is over for now.

A steady and sustainable increase in prices is good news for the local economy, but the more than doubling of the average price since 1998 is probably a sign of too much, too fast. What will the fallout be?

Most of us will be unscathed, except for the loss of party chatter about how much more our houses are worth this year compared with last. Those holding multiple houses that they purchased more recently, or developers of new properties not yet sold, may find themselves less sanguine. It is not gloom and doom for all, as renters and first-time buyers can find improved choices at lower prices.

It helps to sort out what happened. Demand rose faster than supply for about the past five years, so prices increased, and by quite a bit - Economics 101. In a case of self-fulfilling expectations, rising prices were pushed higher by speculative buying. Who these buyers were matters a lot, so more on them later.

Keep in mind that current house prices, like stock prices, are determined by a small number of transactions relative to the total existing quantity of the commodity being bought and sold. Those on the sidelines just watch with interest. With new housing unable to magically appear overnight to satisfy demand, prices spiked. Slowly but surely, new supply followed and continues to follow the higher prices.

Low interest rates and exotic mortgage arrangements played a major supporting role in this scenario. Two other parts of the story warrant telling.

It is probably not a coincidence that this price increase followed the decline in stock prices after their large increase through the 1990s. Investors scorched by the stock market decline and seeking a return to double-digit investment returns sought and found it in real estate. A similar speculative mentality crept into housing, just as it had with technology stocks. A house was not just a place to live but an investment strategy, too.

In the past year, a small increase in interest rates and increased supply reversed the speculative mentality and put a halt to steep price appreciation. As Robert Shiller, the Yale economist who predicted the end of the stock bubble of the 1990s (and is predicting a similar fate for housing) points out, the media also play a part. Tales of making money on real estate became commonplace - and were often true. Of course, shows like Flip this House and My House is Worth What? should be viewed more as an effect than a primary cause of housing price increases.

So, now what? Prices in the next year or two, on average, should be flat, and they will decline in many places. Expect to see lower prices and longer time on the market in the neighborhoods that experienced the largest price increases. Assorted incentives offered by sellers do not show up in transacted prices but amount to lower effective prices nonetheless.

Lower prices are the market's cure for excess supply. How much lower depends on unknown future behavior. It has been reported that in the last half of 2005, 90 percent of Baltimore houses were sold to non- owner occupants. In the first half of 2006, this figure was 62 percent. These astonishing numbers, if even close to being correct, portend major adjustments in the neighborhoods most affected.

A mitigating factor is if these investors decide to rent rather than try to sell. The in-and-out investors would instead become landlords. Rental property management companies may become busy, and renters should find plenty of choices at good prices. The rents expected on high-end housing, however, may not mesh well with the lower incomes of the pool of potential renters.

The supply of newly built housing units will not stop on a dime. Units planned during the boom and now in the pipeline will emerge on the market in the months to come. As was common in Baltimore in the early 1990s, new condominiums offered for amounts well below their original list prices may appear again to clear a saturated market.

In a year or two, the housing market will be back to normal. Most of us will emerge with our house worth much more than it was when we bought it. Those who see a "soft landing" in our immediate future could be right - but that might depend on what constitutes soft and who is doing the landing.

Those making soft-landing predictions are frequently those with skin in the game. They may be expressing their hopes rather than their beliefs. They understand well the way the expectations of buyers and sellers played a major role in making this story what it was on the way up - and that those expectations will play a role in the way it continues to unfold.

Douglas Lamdin is a professor of economics at the University of Maryland, Baltimore County and a Baltimore resident. His e-mail is lamdin@umbc.edu.

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