Decline in home prices highly unlikely, experts say

With prospects for the nation's economy slowly improving, interest rates remaining historically low and demand for housing continuing to be strong, there are few risks for a decline in housing prices on the horizon, according to David Seiders, chief economist of the National Association of Home Builders, and Maury Harris, chief economist of UBS Warburg.

Their analysis was presented in a recent teleconference held by the National Association of Home Builders.

"In an analysis of house prices nationally and by major regions of the country, it is difficult, if not impossible, to find prices that look out of alignment with underlying economic fundamentals," Seiders said. "With the economy and job market in the process of recovering and an interest rate structure that promises to remain historically low, it is highly unlikely we will be hearing any sizable price bubbles bursting this year or in 2003."

Since the end of World War II, average nominal housing prices have not declined nationally, Harris said, and in 2001's recession, housing prices actually rose faster than the inflation rate.

Today's median-income family can afford to buy the median-priced home, Harris said, because "even with rising house prices, incomes have gone up and mortgage rates have gone down."

Harris also noted that the cost of owning homes has not been rising relative to the cost of renting equivalent units, contrary to arguments made by some bubble theorists.

Expansion in 1997 of the tax-free treatment of capital gains on home sales and the recent declines on Wall Street have further increased the demand for housing, Harris said.

"The stock market was the best game in town for a good while, but it hasn't been for the past two years. For the time being, investors have decided that housing is probably going to be a better investment than stocks or bonds or gold," he said.

In a June survey for UBS Warburg conducted by Gallup, 59 percent of the respondents said that investment in real estate was more attractive than six months earlier, Harris said.

Seiders said that "demographics are central to what has been going on, and we have seen persistent demand coming from population and household growth, including a strong immigration component. We got through the recession in very good condition, partly because of a sizable flow of people from rental apartments into the single-family market."

Seiders suggested that instead of comparing increases in house prices to increases in the Consumer Price Index, there is another way of assessing real estate values: "Think about the ultimate anchor for home prices the cost of reproducing a housing unit. What would it cost at the margin to build another one? We've been looking at spreading land-use controls and slow- and no-growth initiatives and their impact upon the availability and cost of lots for housing."

This is a new phenomenon, he said, and it is exerting persistent upward pressure on housing prices.

Harris said that there have been regional cycles in which real housing prices have declined, but these have occurred "in cases where the regional economy has been far, far weaker than the overall economy."

"We are gradually coming out of this recession," Harris said. "The recession should have had the most downward effect on home prices. The bottom line is I don't think it's a bubble."

Speculation over the possibility of a housing price bubble has continued, he said, largely because "if you had a crash in the stock market, you wonder where else can there be a crash."

Seiders forecast that the Federal Reserve would start increasing its federal funds rate next spring, raising it to 3 percent by the end of 2003. By that time, long-term mortgage interest rates may be "touching" 7 percent, about one percentage point higher than they are today.

"But these rate adjustments will be occurring in a stronger economic environment with better income and job growth than we've been seeing this year, " he said.