As Interest Rates Rise, American Home-Price Gains May Slow

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The New York Sun

American home-price appreciation will slow as interest rates rise next year, according to Freddie Mac and Fannie Mae, the nation’s two biggest purchasers of mortgage loans. The slackening may hurt economic growth.


Home prices rose more than twice as fast as wages over the past three years. Personal incomes rose 9.3% since 2001, and prices for new and existing homes surged 19% over the same period, government data show.


Homeowners “should not expect double-digit price increases year after year,” the chief economist at McLean, Va.-based Freddie Mac, Frank Nothaft, said in an interview. “That’s just not going to happen.”


Homes are the most valuable investment of many Americans, worth some $15.2 trillion.


Slower appreciation may make homeowners less confident and eventually hurt spending, said a former Federal Reserve governor and onetime chief economist for the Mortgage Bankers Association, Lyle E. Gramley.


Through mortgage refinancing, owners last year turned a record $138.1 billion of home equity into cash, helping them buy cars, dishwashers, and other goods.


“If the average slows to 4% to 5%, there’d be some negative figures in some parts of the country, and the confidence of those people would be shaken,” said Mr. Gramley, who is now senior economic adviser to Schwab Soundview Capital Markets in Washington.


American economic growth is forecast to slow to 3.7% next year from 4.4% this year, based on the average of 52 forecasts in the latest poll by Blue Chip Economic Indicators.


“People have been pulling money out of their homes, and they have been spending it,” said the co-director of the Center for Economic and Policy Research in Washington, Dean Baker. “That source of demand will largely come to an end” as price gains ebb, reducing economic growth by about 1 percentage point, he said.


Five housing forecasters – Fannie Mae, Freddie Mac, the National Association of Realtors, the National Association of Home Builders, and the Mortgage Bankers Association – predict price gains will start to slow next year. None foresee price declines.


American home-price growth likely will moderate from 7.6% last year to 6.1% this year and 3.7% gain in 2005, said David Berson, economist at Washington-based Fannie Mae, the nation’s largest buyer of mortgages. That would be below the 4.4% average of the last 20 years, according to the National Association of Realtors.


There are signs the run-up in prices already may be cooling. The median price of existing homes rose just 0.2% in July from June to $191,300 after surging 14% since February, and the median new home price dropped 2.6% to $207,400.


As interest rates rise, Freddie Mac’s Nothaft estimates the borrowing homeowners do by refinancing mortgages – so-called cash outs – will fall 48% this year to $71.7 billion, a four-year low. Freddie Mac and Fannie Mae are publicly traded companies whose origins trace to government agencies.


Akron, an industrial city of about 217,000 people in Northeastern Ohio, is one area experiencing an actual decline in prices. The greater Akron region lost almost a fifth of its goods-producing jobs, to 64,000, since July 2000, while service jobs increased from 254,300 to 258,800.The median price of a single-family home in Akron fell 3% to $116,000 in the second quarter from a year earlier, according to the National Association of Realtors. The American median home price rose 9.1% to $183,800 in the same period.


“When you don’t have those high rates of appreciation, you don’t have the option of taking out a home-equity loan for spending,” said Lenda Smith, 60, a real estate agent with Century 21 Twin Oaks in Akron, Ohio. “Down the road, it’s going to catch up with you, and you could sell your house and walk away with nothing or even owe something.”


Federal Reserve Chairman Alan Greenspan in mid-August said policymakers don’t have adequate data to tell whether America is in the midst of a speculative bubble in real-estate price.


“House-price increases have outstripped gains in income and rents in recent years,” Mr. Greenspan wrote in a follow-up response to his July 20 congressional testimony. While that “raises the possibility that real estate prices, at least in some markets, could be out of alignment with the fundamentals,” Mr. Greenspan added “that conclusion can not be reached with any confidence.”


Some Wall Street chief economists, including Stephen Roach of Morgan Stanley and Ian Morris of HSBC Securities Inc., say there’s a risk that surging prices formed a bubble that could pop much as Internet stocks did in 2000, sending home values tumbling.


“The biggest risk to this new strain of economic growth is the time-honored tendency of asset cycles to go to excess,” Mr. Roach said in a July 14 letter to clients. “That was certainly the case when the equity bubble popped in early 2000, and could well be the case again for the property cycle.”


An increase in interest rates may set that in motion, Mr. Baker said in an interview. Price gains nationwide may slow to about 4% annually over the next decade, based on the median estimate from 61 forecasters surveyed.


Three-quarters of those surveyed said they consider houses overpriced in places such as Boston, Los Angeles, New York, and Washington. San Francisco is another region they said may fit Mr. Greenspan’s definition of “out of alignment.”


The median price in San Francisco rose 20% in the year to July to $650,000, 11 times the median household income.


Else Townshend, a real-estate agent since 1987, said one of her clients, a physician, has been unable to find a home even though she’s willing to pay as much as $800,000.”She’s made 20 offers and she’s gotten outbid on each one,” said Ms. Townshend, who works for Zephyr Real Estate in San Francisco’s Castro district.


In Boston, the 11th-largest American metropolitan area, home prices rose 72% in the past five years, even as the region’s unemployment rate almost doubled in the same period.


Karen Kirchoff, 47, is shut out of Boston’s market. The acupuncturist can’t afford to buy in the Roslindale neighborhood where she rents a two bedroom apartment. “When I look at these prices, I don’t think it will ever happen,” she said.


Karl Case, an economist who tracks American house values along with Yale researcher Robert Shiller, said he’s worried about the surge in home prices.


“A slowdown in appreciation would be good for us, because it reduces the probability of a bust,” Mr. Case said. “People will moderate their spending a little bit as equity gains moderate, but it would avoid the scenario I’m worried about: a pop that would lead to price reversals.”


American median home prices haven’t staged a reversal since the Great Depression in the 1930s, said David Lereah, chief economist for the National Association of Realtors.


For now, home-builders say there’s no shortage of buyers.


“What’s driving demand is strong immigration, affordability, and singles buying homes at a faster pace than ever,” said Bruce Gross, chief financial officer of Lennar Corp., the third largest American home-builder by stock market value, in an interview. “Economics 101: Very strong demand and tight supply is leading to continued success for all the home-builders.”


Interest rates would have to rise at least 3 percentage points to affect housing demand, said Richard Dugas, chief executive officer of Bloomfield Hills, Mich.-based Pulte Homes Inc., the fourth-largest American homebuilder.


The average American rate on a 30-year fixed mortgage this week was 5.77%, and the Mortgage Bankers Association predicts a rise to 7% next year. The Fed this year raised its benchmark overnight lending rate by a half-point in two 0.25 basis point gains to 1.5%, the first increases in four years.


More than 60% of San Francisco area buyers now use adjustable-rate mortgages to help them obtain homes, according to DataQuick, a California real-estate data firm, making them sensitive to higher American interest rates.


“I have several clients who are trying to get their properties ready as fast as they can” to sell, Ms. Townshend said. “They think that after the election, interest rates are going to go up much higher.”


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