Are home prices irrationally exuberant?
If you own a house in any of the three dozen metropolitan areas where appreciation rates exceeded 20 percent in the past 12 months, you might think so. Ditto if you live in one of the 14 major markets where the average home more than doubled in price in the past 60 months alone. That's pretty exuberant by all historical standards.
But are any of these hyperinflationary areas, primarily in California, Nevada, Florida, New England and the Mid-Atlantic states, heading for significant corrections in values this year? Could one or more of these bubbles go pop?
New economic research offers both disquieting and reassuring answers.
Some of the frothiest local markets are exhibiting unmistakable signs of speculative fever. One hint is the percentage of house and condo purchases by investors -- non-occupant buyers in pursuit of capital gains rather than residences.
Nationwide, 8.4 percent of all home purchase loans made by lenders in 2004 went to non-occupant investor buyers, according to the San Francisco-based research firm LoanPerformance Inc. But in Las Vegas, which was by far the fastest-appreciating housing market in the country last year at a record-setting 41.7 percent, the proportion of investor loans was 16.1 percent, almost double the national average.
In Miami, where the housing price appreciation rate last year was 23.6 percent, 11.3 percent of all new purchase mortgages went to investors. In Los Angeles, 10.4 percent of new loans went to investors, while housing prices soared by 30.5 percent.
Another disquieting sign in some high-gain markets has been a rapid surge in interest-only mortgages, which allow buyers to make artificially low monthly payments for initial periods ranging from two to five years, followed by sharply higher payments afterward. Many interest-only buyers either cannot afford to buy high-price houses at standard interest rates or expect to flip the property at a profit before the higher payments kick in.
Interest-only loans accounted for barely one-third of 1 percent of all new home purchase mortgages in 2001, according to LoanPerformance, but now account for 14.5 percent of purchase loans in red-hot San Diego, 10.5 percent of new loans in Boca Raton-West Palm Beach, Fla., and 13.2 percent of loans in Las Vegas.
Other forms of payment-reduction also are booming in high-fizz markets, including mortgages that allow buyers to set their own payment levels and rack up substantial "negative amortization" -- that is, adding to the principal debt on the property month after month, rather than reducing it.
All those techniques increase home buyers' leverage -- their ability to acquire high-price real estate at minimized costs. But they also increase their risk of losing the house should their incomes or appreciation rates drop unexpectedly.
Which raises what one mortgage economist calls "the leading question of the new year:" Could any of the major bubble markets go pop in 2005?
In a new study, economist Michael D. Youngblood identifies 27 local housing markets that have reached bubble stage. Youngblood, who works for Friedman, Billings Ramsey & Co., an investment banking firm based in Arlington, defines bubble markets as those where income growth rates per person severely lag housing price growth and are seriously out of sync with historical price-to-income norms.
Most of the bubble markets in Youngblood's study are in California, but a few are not, including Boston; New York; Honolulu; Boulder, Colo.; Danbury, Conn., and Bellingham, Wash. Notably absent from Youngblood's list are all the high-appreciation markets in Florida, plus metropolitan Washington and Philadelphia, where household incomes have lagged housing price increases, but the ratios of which are still within historical norms.
Are there dangers of busts in any of the 27 bubble markets? Youngblood comes to this reassuring conclusion: Even in the highest-flying markets, it would take four straight quarters of economic recession -- rising unemployment, flat or declining household incomes -- to precipitate a housing price bust. And not one of the 27 has yet racked up even one quarter of recession, Youngblood said. Any serious housing price deflation -- if indeed it is in the cards -- is unlikely for at least a year.
That's not to suggest that appreciation rates are likely to keep humming along in the double digits indefinitely. Price gains of that magnitude are not sustainable. They eventually burn themselves out by making housing unaffordable to all but a small percentage of potential buyers.
Youngblood and many other mortgage economists expect a slowdown in the rate of housing price growth in even the zestiest markets in the coming year or two. But no busts.
Kenneth R. Harney's e-mail address is KenHarney@earthlink.net.