Real estate boom to bust

June 23, 2004

Housing market could drag economy down

By Glenn Roberts Jr.
Inman News

The bottom is likely to drop out of the housing boom within the next couple of years, and this downturn will probably be accompanied by an economic recession, according to a University of California, Los Angeles, forecast.

"Absent something of the magnitude of the Vietnam War, we should expect a housing collapse and an attendant recession. Probably late 2005 or 2006, though it is impossible to say when right now," said Edward E. Leamer, director of the UCLA Anderson Forecast. "We are building up the same kind of mountain of home spending that eventually crashed into the valleys of eight recessions."

If the downturn doesn't occur by the end of 2006, it will probably happen before the end of the decade, Leamer states in the national forecast report. "Now, when the weather is great, is the time to prepare for the storms coming later," he states.

The report, titled, "Normal, again," notes that since World War II there "has only been one decline in the ratio of spending on homes to (gross domestic product) that did not lead into a formal recession."

A rise in long-term interest rates of 200 basis points or so within a two-year to three-year period are another precursor to recessions, the report states, and interest rates have already risen about 100 basis points in a short time. "How much more is needed to terminate the housing boom?" Leamer said in the report. "It's a rise in long-term interest rates that kills off housing."

Long-term interest rates have increased steadily this year, with rates on the 30-year mortgage at 6.32 percent and rates on the 15-year mortgage at 5.7 percent, according to Freddie Mac's latest survey.

The abnormally low interest rates of the past couple of years have been "stealing (home and car) sales from the future, and guaranteeing weakness in these critical marketplaces in the years ahead," the report states.

"Today’s buyers who think they will be selling at a profit in the next several years need to understand that they are placing a bet that these low mortgage rates will be with us until they want to sell," Learner says. "Today’s buyers with a longer perspective need to do an entirely different calculation to decide if properties today are overpriced."

The forecast calls for a drop in housing starts from 1.87 million this year to 1.59 million in 2005, and then a slight increase to 1.64 million in 2006.

The Anderson housing market forecast for California calls for a slowing in existing home sales, but no collapse. " Home prices have risen about 77 percent over the past three years, the California forecast states, and high home prices and rising mortgage interest rates are likely to muffle the housing boom. But the short supply of new housing "will keep demand fairly strong," the report states. The number of residential building permits in the state is expected to drop from 206,500 this year to 198,400 in 2005 and 195,000 in 2006, according to the forecast.

A regional Anderson forecast for Southern California reports "a clear bubble in (home) prices—despite tight supply. Eventually there needs to be some return to sustainable price levels—likely when interest rates continue to rise through 2004." This downturn in the Southern California housing market will likely slow new residential construction. Also, rising mortgage interest rates could force homeowners to cut spending in other areas, impacting the area's overall economy, the report states.

Increases in Southern California home prices have outpaced the rise in San Francisco Bay Area home prices since 1995, largely due to appreciation over the past six months. Prices in the region are about 80 percent higher than they were seven years ago. "It is clear that even when adding in tight supply and falling rates, we still cannot explain all the appreciation seen in local housing," states Christopher Thornberg, senior economist for the Anderson Forecast.

"Hence some correction will be necessary to bring prices back into line with a long-run stable price," he says in the report.

The Inland Empire, an area in Southern California that has experienced "white-hot activity levels" in the housing market, will experience a mild downward trend in home sales through the rest of this year, and local housing construction will "begin to provide a slight drag on local job growth, rather than the strong stimulus it has provided since early 2001," another forecast report states.

But new home sales will help to sustain rapid population growth in the area, the report states, "and that will drive continued growth in retailing and consumer services."

Copyright: Inman News Features

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