Up, up, and... then what?

Rising home values helped keep the recent recession shallow. They've also added more than $1 trillion in household wealth so far this decade. To some, that says 'bubble.' But most experts insist that the sky's the limit.

Carol Ann Shea finds herself "astonished constantly" at the high price of homes in this upper-middle-class suburb of Boston. A "pretty ordinary house" with three bedrooms, 1-1/2 baths, usually sells in the "upper 400s, lower 500s," says the Century 21 real estate agent.

"Half a million dollars is a lot of money," Ms. Shea says. "I don't see it as affordable."

Yet the buyers keep coming, snapping up houses. And the average home price keeps rising – more than 6 percent a year.

Nor does Shea see this as a price "bubble" – something the Boston region experienced in the 1980s until it burst about a decade ago. Many experts agree.

"Demographics say the housing market is sound," says Mark Duda, a research analyst at the Joint Center for Housing Studies of Harvard University in Cambridge, Mass.

Looking at such factors as high immigration numbers and the formation of new families, Mr. Duda figures the nation will add almost 22 million new homeowners by 2020 on a net basis – after the destruction of houses by urban renewal, fires, tornadoes, etc., or just plain wear.

"You are talking of substantial growth," he says. "That will put a floor under the housing market for several years to come. We are not calling this a bubble."

Of course, most Americans don't pay Newton prices for their homes. In March, the median price in the United States for an existing home was $153,000. That was a 6.7 percent increase from a year earlier. The median price for a new house was $176,700, up 6.3 percent from the previous March. (See chart, page 19.)

Further, the housing industry is enjoying a boom. Last year, 1.6 million housing units were started, including about 350,000 multifamily dwellings. Some 909,000 new units and 5.3 million existing homes were sold, for a total of 6.2 million.

"An all-time record," says Frank Nothaft, chief economist for Freddie Mac, a company that purchases the mortgages of 1 in 6 homebuyers and the apartments or other housing of more than 2 million renters in the US.

Mr. Nothaft sees house sales this year coming "very close" to that 2001 record, helped by good weather this past winter.

Yet there is some nervousness about today's house prices.

That's especially so in such high-price locations as the Boston region, New York, Miami, San Diego, and the San Francisco Bay Area. In the Bay Area, the collapse of many dotcom companies has already trimmed prices.

A peak in foreclosures?

Some data suggest trouble. In the last quarter of 2001, the number of foreclosures in process nationwide moved up to 1.04 percent of a sample of 30 million mortgages from 0.85 percent the year before.

But the number of mortgage loans in which homeowners are delinquent on their payments fell slightly to 4.65 percent in the fourth quarter of 2001, from 4.87 percent in the previous quarter. That leads Douglas Duncan, chief economist of the Mortgage Bankers Association of America, to suspect that the peak of foreclosures may be past.

"Are home values going to crash?" asks Nothaft. "Absolutely not. Will there be some markets that will be down? Absolutely."

The last time annual average house prices across the entire US fell was during the Great Depression, more than 60 years ago. Duda figures prices will rise "a little slower" in the years ahead.

This year, house prices will increase 3 to 4 percent, predicts Nothaft. That compares with a 7 percent clip in each of the past two or three years.

One concern is affordability. If house prices continue to rise faster than incomes, will lower- or middle-income people be able to cover payments on a house?

Banks and other makers and buyers of mortgage loans own, in a sense, a large chunk of homes. In 1982, homeowners themselves held about 70 percent of the total value of their homes on average. Now it is about 55 percent. That shift, explains Mr. Duncan, is largely explained by the growth in home ownership.

The proportion of households who own their own homes has surged to a record 68 percent in the fourth quarter of 2001, up from 64 percent a decade ago. More low-income households have been able to buy their own homes.

The latest census data shows that 5 percent, or almost 2 million, of 38.6 million homeowners with one mortgage or more had no equity or negative equity in their homes. Another 7 percent had less than 10 percent equity in their own homes.

Ingo Winzer, who compares family incomes with home prices in 100 housing markets in the US as an indication of affordability, finds that the number of "overpriced" markets is higher than it has been in the past 12 years.

Later this year or next year, the president of Local Market Monitor in Wellesley, Mass., expects to see home prices generally stagnate, and in some areas dip. Some worst- case markets will be manufacturing areas, such as Santa Clara, Calif., and Austin, Texas, both hit by the drop in computer-hardware sales.

Though home prices are up about 100 percent over the past six years in the Boston region and thus "overpriced," there also is a dearth of building sites that are properly zoned in many areas. So prices "may not fall," Mr. Winzer says.

In the case of upscale Newton, Shea finds that buyers tend to be two-income young professionals, those who have inherited wealth, and families shifting from smaller homes or condominiums in nearby towns for the good schools, nearness to Boston itself, and the easy public transportation of Newton.

The $300,000 house – "an unusual commodity" in Newton – often takes longer to sell than higher-priced homes, Shea says. Home shoppers don't so often come to Newton to seek such relatively modest homes.

When will rates rise?

Another worry for home builders and buyers is the possibility that the Federal Reserve will start raising short-term interest rates sharply later this year and that mortgage charges will follow.

But Nothaft expects that the interest on a 30-year fixed-rate mortgage to average 7.1 percent this year, barely above their current relatively low rate of 6.9 percent.

One concern the Fed has in raising interest rates is its impact on consumer spending.

Fed Chairman Alan Greenspan has noted that the steaming housing market has helped prop up the economy, making the recession of last year the shortest and shallowest on record.

Last year, Americans did a record $1.2 trillion of mortgage refinancing. The average reduction in interest rates of 1.15 percent is saving most households about $100 a month. In the process, house owners also took out $100 billion in home-equity loans. They spent the money on home improvements, college costs, reducing credit-card debts, or perhaps some investments.

This year, says Nothaft, about one-third of homeowners with mortgages will refinance, compared with 55 percent last year.

The 'wealth effect'

Americans still have a huge amount of home equity, which makes them more willing to spend income on other goods and services. It's called the "wealth effect."

Americans regard house wealth as more permanent than the volatile, and perhaps transitory, wealth they have in stocks.

Moreover, though as many as half of Americans own stocks directly or indirectly, most stock wealth is held by the richest 20 percent of households.

House wealth, in contrast, is spread over households at all income levels, except for many of the poorest families.

In testimony to Congress last month, Mr. Greenspan noted that household wealth relative to income has declined since the end of 1999. Since levels of personal wealth can be crucial in consumers' purchasing decisions, this wealth decline is "likely to damp the growth of consumer spending in the period ahead," he testified.

It also explains most of the drop in savings from 1995 to 1999 as consumers felt that their growing wealth allowed them to spend more. Savings have risen a little lately, along with growing economic uncertainty.

An academic paper by economists Karl Case, John Quigley, and Robert Shiller finds that in the US and 13 other industrial nations, the wealth effect of trends in stock-market prices is "weak." But changes in housing wealth have "important effects on consumption."

In the US, a 10 percent gain in housing prices prompts an average 0.62 percent increase in consumption, the economists write. The same jump in stock- market wealth elicits only a 0.2 to 0.3 percent increase in spending.

Greenspan explains that one reason house values and wealth change much more slowly than stock prices is that sales in the real estate market incur substantial costs. These include fees of real estate agents and closing costs. Moreover, sellers and buyers often pay thousands of dollars in moving costs.

This is "an obvious impediment to stimulating a bubble through speculative trading in homes," Greenspan said.

The turnover of home ownership is less than 10 percent annually, far less than the more than 100 percent turnover each year in stock ownership. And housing markets tend to be local – not national.

Mortgages go national

Changes in the mortgage business have also made the housing market more stable.

Mortgage loans used to be made mainly by local bankers on the basis of local conditions and then held in their own investment portfolios.

Now, two-thirds of home loans are bought in secondary markets from the banks or other financial institutions that make the original loans by Freddie Mac, Fannie Mae, or other major financial institutions.

Loan money is less likely to dry up if one region's economy struggles.

There are more reasons so many Americans want to buy a home.

Some are afraid that if they wait, a house will only cost more. They like the tax advantages of mortgages. They figure that even if house payments are a burden, eventually their home will be worth a lot more than they paid for it.

And, many experts figure, they are probably right.

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