More Than a Bubble Keeps Housing Prices Sky-High

If you were playing a word-association game with most Americans today, the phrase “housing prices” would probably prompt the response “bubble.”

But does a real estate bubble really exist? Builders and real estate agents pooh-pooh the notion. Industry analysts give ambiguous responses. Economists caution that cycles are, well, cyclical and do not ascend forever. Homeowners, delighted at the rise in their net worth, fear a downfall. And would-be buyers are gauging the opportune time to buy: Should they wait for the bubble to burst, when prices will fall? Or should they buy now, before the cost of a fixer-upper rises into the stratosphere?

In the Harvard Joint Center for Housing Studies’ latest State of the Nation’s Housing annual report, we looked hard for a bubble. Indeed, we have looked for one in each of our recent reports -- after Sept. 11, after a national mini-recession, after the United States went to war with Iraq.

So far, we haven’t found one. Since 2000, the national median house price increased 23%, to $170,000. Los Angeles residents saw a 64% increase, to $355,000. It was not just home prices that soared. Home sales, single-family housing starts, homeownership rates, mortgage refinancings -- all went through the roof. Admittedly, both the rental market and the manufactured-housing sector flagged, but even with higher vacancy rates, rents increased in more areas than they decreased.

With rising interest rates, however, the Cassandras are predicting a free fall. It came for the dot-coms, they reason; housing is next.

We see no such calamity on the horizon. Three fundamental conditions have undergirded this sector, and they have not changed.

First, demand remains high. We estimate that household growth between 2005 and 2015 will be 10% higher than previously projected; in short, the nation will be adding 13 million to 14 million net new households -- a higher increase than in the 1990s. Immigration is up (the Census Bureau revised its projections earlier this year). But even if immigration slowed, the immigrants who arrived in the 1990s will be the households buying homes from 2005 through 2015. Add the demand for second homes and replacements to units lost from the stock. From 2005 through 2015 the nation may be adding 2 million to 3 million more homes than were built in the boom decade of the 1990s.

Second, no-growth and slow-growth restrictions continue to constrain supply. The inventory of unsold new homes is at a historical low. In past cycles, an eight-month inventory was a bellwether that triggered a drop in housing construction. Today it is four months. We have fewer unsold new homes on the market today than we had in 1978.

Third, the consolidated financial services industry, with access to global capital markets, is flexible. The cost of mortgage origination and servicing has fallen. As long-term interest rates rise, many home buyers are likely to choose adjustable-rate or hybrid mortgages. In January 1995, 59% of buyers opted for adjustable-rate mortgages; today only 30% do. A moderate increase in rates, moreover, is not likely to depress sales: In 2000, when the rate was 8%, home sales and prices were rising.

If we do not see a national housing bubble, however, we do see regional variations. On the East and West coasts, the escalation in housing prices has doubled some homeowners’ net worth; but for much of the middle of the country, home prices have paralleled income growth. And localized bubbles happen.

Since World War II, the national median home prices never declined from one year to the next, but in specific regions prices have fallen, tied to rising unemployment and extraordinarily high prices.

Furthermore, although higher interest rates might not depress home sales, the increase will dampen enthusiasm for refinancing. Homeowners have been using their homes as ATMs. In 2003, homeowners cashed out $139 billion. Fewer refinancings and home equity loans will translate into lower consumer spending, which can raise unemployment.

We also continue to see a stratum of Americans who struggle for shelter. Nearly a third of all households spend more than 30% of their income on housing. More than one in eight spend above 50%. And the one worker in four earning less than $10 an hour is not thinking about a bubble; even a moderation in home prices will not help him.

At the same time, the federal deficit rises to pay for tax cuts and the war on terrorism, leaving bleak prospects for expanded domestic government spending.

Unfortunately, we see no change in those statistics -- bubble or no bubble.