'80s housing view: cost spiral tamed, financing stiffer

Homeowners -- don't expect house prices to rise so fast in the 1980s as in the '70s. Prospective homeowners -- it is going to be more expensive to buy a house this decade.

Those are two predictions of Anthony Downs, a senior fellow at the Brookings Institution, specializing in housing and urban affairs.

During the 1970s, United States homeowners enjoyed a bargain. From 1968 to 1979 to median sale price of existing homes rose at a compound annual rate of 9. 7 percent. The price of new homes climbed 8.9 percent a year. The consumer price index during that period increased only 6.9 percent on average, obviously soaring faster later in the decade. So the price of existing homes rose 41 percent faster than prices generally.

Moreover, most homeowners had a highly leveraged investment. They paid 20 or perhaps only 15 percent down and borrowed the remaining money. That meant that any significant rise in the price of the house produced a huge return on the householder's own equity.

Mr. Downs gives an example of a California home bought in 1976 and 20 percent down. Since the median price of existing homes sold in California soared at a compound annual rate of 20.9 percent from 1976 to 1980, the initial equity in the typical home jumped by more than 100 percent every year. That calculation doesn't deduct mortgate interest charges or other housing costs.

For the nation as a whole, the annual gain was something like 63.5 percent per year. That's a pretty good deal, to say the least.

What's more, the homeowner could deduct his interest charges and house taxes from his federal tax load.

Finally, most homeowners were borrowing the money free. In fact, financial institutions were in effect paying householders for the privilege of lending them money. Downs takes an interest rate example of 12 percent, one that is high compared with many outstanding mortgages, low by today's 17 percent rates. If prices rise 10 percent a year, the real rate of interest is 1.8 percent before taxes for the first year (1.12 divided by 1.10). The rate falls to minus 2.5 percent after taxes for people in the 40 percent tax bracket. And if the house itself rose in value at 12.7 percent a year, as it did in the late 1970s, then even the before-tax rate is negative and the after-tax rate is minus 4.8 percent. That's a sweet investment.

But the situation has changed.

First, median prices of existing houses declined 5.3 percent from July 1980 to July 1981. Actually, because so many sellers had to take some of the financing themselves at lower-than-market interest rates, the real price decline was probably closer to 6 percent, Mr. Downs guesses. Housing hasn't suffered such a large price decline in 15 or 16 years, he says. In that same 12 months, the consumer price index rose 10.7 percent.

Second, there has been what Mr. Downs terms a "revolution" in real estate financing. "The lending community has changed its expectations on inflation," he noted in an interview. Previously, savings-and-loan executives and other lenders of mortgage money figured that a burst of inflation would be followed by slower price increases. They got burned in the 1970s.

Thus they have decided inflation is here to stay, or at least they are uncertain as to the future. So they have increasingly insisted on mortgage instruments that reflect changing interest rates. The householder is having to take some of the risk of inflation escalating again through rollover mortgages, variable-rate mortgages, and variations on these themes. In the area of nonresidential buildings, lenders are taking equity participations or partnerships in some cases.

"This is very reasonable behavior on the part of the lenders," Mr. Downs says.

The Brookings expert does not expect lenders' inflation expectations to change rapidly. So he predicts that mortgage interest rates will remain in the low double-digit area for several years.

Nor does he believe housing prices will go up so fast this decade, indeed probably only about the same rate as the consumer price index.

This combination of higher financing costs and lower capital gains will make it more difficult for many individuals to buy a house. But Downs does not believe this will be disastrous. "People will not be living in the streets," he says. "This isn't a move toward dire circumstances."

In fact, he believes the nation is "overhoused." In 1979, for example, 22 percent of all home purchases were made by single persons. Many of these bought houses far larger than they actually needed as an investment. Housing was cheap in real terms.

In the 1980s, however, the rising cost of homes in real terms will mean relatively fewer household formations and some "unsingling." Individuals will share houses. There will be more demand for rental housing.

The supply of new rental housing has been inadequate, however. Rents could not rise fast enough to encourage new rental housing, because single-family housing was such an inexpensive alternative. Further, in some areas rent control has discouraged construction of rental apartments.

President Reagan has appointed a commission to study the housing problem. It is to report its initial findings in October and make a complete report next April. What should it suggest?

Downs is opposed to any more general housing subsidies, such as the deductibility of interest charges and local taxes. He would favor a federal ban on rent control (with some phasing-in period for New York City). This would allow rents to climb fast enough to make the construction of rental housing again attractive.

Meanwhile, he suggests, the poor might be aided by a housing voucher system that has proved to be relatively successful in federal experiments over the past decade. The poor would be required to pay perhaps 35 percent of their income for housing, but get an allowance covering any excess amount up to the median rental prices in their area.

But he doubts the Reagan administration will accept any new subsidies for the poor.

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