The Heat’s On in Housing : Too Many Americans Are Banking on Their Equity
The good burghers of Yonkers, N.Y., say that they are not racists for opposing the construction of public housing in their middle-class neighborhoods. They say that their real concern is real-estate values. Actually, I believe them. Or at least I find it plausible.
According to one Yonkers real-estate agent, a three-bedroom house purchased for $18,000 to $30,000 in the mid-1950s would sell for 10 times as much today. For these homeowners, this unexpected bonanza is their nest egg. (Nationally, real estate is 60% to 70% of the average person’s net worth.) If the realtor is right that public housing might knock 10%--$25,000 or so--off nearby house prices, that seems reason enough for Yonkers’ panic. Thus the real significance of the Yonkers episode may be to illustrate again how our society is being twisted and torn by the enormous run-up in real-estate prices.
There are signs that the run-up may be over, and growing nervousness that real estate may be heading for a crash. Nationally house prices are just barely rising. The median price of an existing home rose 3.7% during the year ending in July. That’s less than inflation, and much less than the average homeowner’s mortgage rate.
The main reason to think a real-estate crash might be coming is the huge gap between the cost of owning a house and the cost of renting one. For two decades, house prices have gone up twice as fast as rents. A four-bedroom house in a fancy Washington suburb might cost $500,000 (up from $400,000 last year). That house can be rented for $2,400 a month. Figuring everything, the cost of buying a house in Washington is more than double the cost of renting one.
Why would someone pay twice as much to live in the same house? Yes, there are tax benefits, but not nearly enough to explain the differential. The romance of home ownership may be part of it. However, the main reason is clearly the belief that prices will keep going up. When today’s price is simply a bet that tomorrow’s price will be even higher, you have a classic speculative bubble. As investors in pyramid schemes throughout the ages have learned--and as stock market investors were reminded last year--the “greater fool” theory can’t be right forever.
Of course, people have been saying this about real estate for years, and have always been wrong, so far. What’s the evidence that this time is different? First, there’s today’s price slowdown, which comes when times are generally good and interest rates are relatively low. A market that’s counting on future increases to support today’s prices can turn a slowdown into a rout pretty quickly.
Second, there’s tax reform. Slicing marginal tax rates made tax deductions less valuable, thereby increasing the after-tax cost of home ownership. This is still just beginning to sink in.
Third, there are 28% more houses on the market than a year ago. That’s ominous. Comstock Partners, a New York financial firm that is spreading the real-estate crash scare, advises homeowners to sell out and rent. I certainly lack the courage to take this advice. But if even a few homeowners become persuaded that prices are about to topple, then they’ll be right; prices will topple.
A real-estate crash would be far more traumatic than the stock-market crash. Not only do people have more invested in their houses than in stocks, but that investment is heavily leveraged through mortgages. A 25% drop in prices (which Houston has already suffered) would wipe out many homeowners’ entire investment. No one knows to what extent the consumer boom of recent years has been fed by people’s belief that their houses were making them rich. A real-estate nose dive might easily lead to the recession that the stock-market crash did not.
On the other hand a decline in house prices, if not a crash, would be a healthy development. Who would really be harmed? Not young people who haven’t yet bought a home. In 1950 it cost 14% of the average 30-year-old’s income to buy the median home. Today it costs 44%. At those levels, many can’t even qualify for a mortgage. The fraction of young Americans owning homes has dropped dramatically. Most people who already own homes are either going to live in them for many more years or trade up. Regional variations may affect them, but in general the houses they sell and the houses they buy will go up or down together.
The group hurt by a downturn in house prices would be older people selling their last house. But these folks are likely to have bought for a small fraction of today’s prices. It’s rough justice if they make a smaller profit and home ownership becomes more affordable for young people.
The bloated prices of existing houses may make the owners feel rich, but they add nothing to the nation’s wealth. A house is exactly the same house after it doubles in “value.” In fact, as my favorite economist, Henry George, pointed out a century ago, inflated land values make the economy less efficient. They operate like a tax on the truly productive factors, labor and capital.
Housing inflation has depressed our economy, frenzied our psyches, divided our society. A turnaround would be nerveracking, but no bad thing.
