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As home prices rise around the country it's been
difficult to overlook an emerging thought: California
has become our national pricing model.
The surge of home prices seen nationwide very much
resembles what has been seen over many years on the
West Coast and in a few other housing hot spots: Real
estate values increase to a point long-regarded as
unsustainable -- and then continue to rise.
In this scenario there is both good news and bad. If
you're a property owner -- someone selling or seeking
to refinance -- then rising prices are to be
applauded. If you're a local government, rising home
values automatically mean more tax revenues without
the need to impose new taxes.
Alas, if you're a humble buyer then the constant pace
of rising values makes ownership increasingly
unreachable.
Despite rising prices, there is an argument to made
that home prices are generally affordable.
"General housing affordability conditions remained
favorable but declined in the second quarter, largely
(as) the result of higher home prices," says the
National Association of Realtors. (parenthesis mine)
NAR's housing affordability index, shows that a
"median-income family had 120.8 percent of the income
needed to purchase a median-priced existing home,
which was $208,500 in the second quarter. The typical
family, earning $56,917, could afford a home costing
$251,900 in the second quarter."
I have no doubt that such information is
mathematically correct and that nationwide the average
household can readily afford to buy the average house
-- unless that average house is in a major
metropolitan area, the places where most people
actually live. Then I have my doubts, given that in
many metro areas the relationship between home prices
and wage rates is grossly unbalanced.
As evidence, consider that in the first quarter of
2005 NAR reported that 66 metro areas showed double
digit annual price increases. It doesn't take a study
to know that income has not kept pace.
The catch is that it's not just exploding prices in
metro cores. On a recent house-hunting trip we saw a
well-maintained, modest home on a one-acre lot so far
from downtown areas that cows ambled across the
street. The price: $450,000 -- better than twice the
national median value for a decidedly-rural location.
If you've won the lottery or just received a pharmacy
degree, rising home prices are not much of an issue.
But for many people swiftly increasing real estate
values make ownership remote if not impossible.
What is causing rising home prices? In the main there
are three factors:
* Demand is outpacing supply in most metro areas,
in part because new construction is being limited with
local building moratoriums.
* New mortgage products that reverse traditional
levels of lender prudence -- flexible payment (option)
loans, interest-only financing, stated (no tell)
mortgages -- allow additional borrowing and bring
increased numbers of buyers into the marketplace,
fueling higher prices.
* Interest rates below 6 percent -- the lowest
rates seen in decades -- continue to be available.
Minimal inflation levels make low interest rates
acceptable to lenders.
However every few weeks for the past year or so the
Federal Reserve has raised short-term interest rates.
The idea is to stem the oncoming tide of inflation,
assuming there is to be an oncoming tide which
requires stemming.
The result of the Fed's good works is that the federal
funds rate -- the overnight cost of money to banks --
now stands at 3.25 percent. At the same time,
Bloomberg reports that rates for the 10-year bond
stand at 4.125 percent as this is written.
These numbers suggest inflation is being contained and
that investors see little inflation in the future.
This is good news for real estate because such
perceptions tend to hold down mortgage interest rates.
The catch is that if the Fed continues to raise
short-term rates they may soon hover above long-term
rates -- creating what economists call an "inverted
yield curve," a fancy expression meaning that a
recession may be looming.
In effect, while the Fed has raised short-term rates
nine times since June 2004, it has little room for
additional increases before setting off recession
worries. It will soon need to back-off short-term rate
increases simply because low long-term rates suggest
there is no meaningful inflation to contain.
The result? As improbable and contrary as it seems,
pressure to extend low interest rates may continue
longer than just about anyone thought. Such low rates
mean strong real estate demand can continue and with
demand still-higher prices.
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