No Magical Answers
Even Wizards of Real Estate Hesitate to Predict 2006

By Kirstin Downey
Washington Post Staff Writer
Saturday, December 31, 2005

Q: If real estate prices keep climbing, I'll be priced out of the market. Should I buy now?

Are real estate prices tanking? Should I sell my investment condo now?

What's going to happen to home prices in MY neighborhood?

Oh, to have an accurate crystal ball.

Real estate became an obsession among area residents in 2005 as prices seemed to move out of the reach of ordinary people. But now people who watched the market go up, up, up are wondering if it could go down, down, down. And not even the wizards of real estate forecasting know the answer.

In the Washington area, the cost of the median-priced home -- the point at which half the houses cost more and half cost less -- climbed to $429,200 by mid-year 2005 from $243,300 in 2002, a 76 percent increase, according to the area's multiple listing service. In the first half of 2005, prices appeared to be swirling almost out of control, as eager buyers bid up the prices, waived their rights to home inspections and even penned pathetic little notes pitching themselves as the most attractive purchasers to picky sellers who acted more like they were giving a child up for adoption than conducting a real estate transaction.

Nationwide, more homes have been built in 2005 -- more than 1.2 million -- than were built in any year since the federal government began counting 40 years ago. Although complete annual figures have not yet been tabulated, homes are expected to have sold for record-high prices. The construction boom was a shot in the arm for the nation's economy, as new homeowners bought furniture, decorated and landscaped their abodes.

But the surge in prices had uncomfortable side effects for renters, home buyers and homeowners. Renters worried that delaying a purchase meant being priced out of the market forever. Those who took the plunge sometimes were compelled to turn to weird new mortgages to find toeholds in the market. And homeowners found themselves considering cashing in the old family homestead lest one day their children view them as foolish money managers.

Then, in the second half of the year, a slowdown set in. Homes began selling more slowly and prices appeared to be dipping slightly, leaving buyers and sellers agonizing about whether they had jumped too fast or waited too long.

Wrestling with such potentially life-changing decisions, people turned to experts for guidance.

But it's hard to find a good soothsayer these days. The Oracle at Delphi has been out of business for centuries; visitors these days find themselves standing on a mountainside amid a picturesque pile of rubble, gazing out over a landscape of ruined temples.

It's not as if she did such a good job in the first place. "The prophetess always phrased her verdict to be subject to interpretation, to be an enigma," said Achilles Paparsenos, a spokesman for the Greek Embassy in Washington. "Those who sought the advice of the oracle would find the answer unclear."

And so it is with today's oracles, the economists that Americans turn to for modern-day answers.

"Obviously none of us really knows," conceded James Glassman, senior economist with JP Morgan Chase & Co., at a recent news conference at which he spoke along with David Seiders, chief economist at the National Association of Home Builders.

Generally speaking, Glassman, Seiders and other economists think the market will be good, though not as good as it has been in this record-breaking past year.

"Many of us are looking for some kind of a weakening process in 2006," Seiders said, projecting that interest rates on 30-year fixed-rate mortgages will rise to 6.75 percent next year, up from less than 6.3 percent now.

"It's reasonable to assume that real estate appreciation will slow quite significantly in the coming year; I wouldn't be surprised by single-digit [appreciation] rates of 5 percent to 8 percent," said Glassman.

Of course, these prognostications should be taken with a dose of skepticism. A year ago, for example, several prominent industry economists underestimated the strength of the 2005 market, according to a report by Inman News, a real estate news service. David Lereah, chief economist of the National Association of Realtors, for example, thought that 6.38 million existing homes would be sold; 7.11 million were actually sold. Douglas Duncan, chief economist for the Mortgage Bankers Association, thought that the national median price would climb to $190,300; it actually rose to $229,000. And Seiders thought interest rates on 30-year fixed-rate mortgages would rise to 6.5 percent, but they reached an average of just 5.8 percent.

It's always hard to gauge the market. Among the uncertainties that affect forecasts are job and economic growth, the employment rate and interest rates. Then there's housing affordability, seasonal home-purchase patterns, household net worth, pay rates, productivity gains and prospects for inflation.

This year, several other factors are complicating the forecast process, including unexpectedly high energy prices, the aftermath of Hurricane Katrina and the growth of nontraditional loans.

These loans are different from the standard 30-year, fixed-rate models that historically have made up the bulk of the U.S. loan market. In January 1990, fewer than 2 percent of borrowers took out adjustable-rate loans, but at the end of 2005, a third of new mortgages were adjustable. With interest rates rising, many borrowers' mortgage payments are likely to leap at some point in the next few years. Some borrowers will be hit hard, according to a recent report by Friedman, Billings, Ramsey & Co., which found that average annual mortgage payments for some borrowers could rise by 11 to 27 percent. If adjustable-rate mortgages come to be seen as unattractive, and fixed-rate mortgages become too costly as interest rates rise, fewer people will buy houses. Demand will fall.

The Friedman economists also examined the potential impact of higher energy prices on borrowers, particularly those with adjustable-rate mortgages, asking whether homeowners will have the financial wherewithal to handle both higher energy prices and higher mortgage payments. Since June 2004, gasoline prices have climbed 18.1 percent, natural gas rose 15.2 percent and heating oil rose 49.7 percent, the study noted.

Furthermore, natural gas prices may increase 48 percent or more this winter, according to the Energy Department's Energy Information Administration.

The Friedman economists concluded that people will be able to manage hikes on both fronts, possibly by taking in roommates or cutting their discretionary spending -- both life choices that could make homeownership less attractive.

An issue of particular concern in the high-cost Washington area is the recent decision by federal banking regulators to cut back on so-called "exotic loans," such as interest-only loans and mortgages that allow borrowers to make partial payments on their loans. In 2000, only 1 percent of Americans who got new loans selected the interest-only variety, but by mid-year 2005, about 23 percent of borrowers were using them, according to LoanPerformance Inc., a real estate lending information service. About a third of Washington area residents opted for these loans in the past year.

Many borrowers did so because that was the only way they could afford to purchase homes as prices climbed out of reach.

Both kinds of loans -- interest only, and the pick-a-payment variety known as "option ARMs" -- can cause mortgage balances to rise, in what is called negative amortization. That can leave borrowers at financial risk if home values fall. Regulators fear these loans could pose risk to banks if borrowers default on their mortgages. The Office of the Comptroller of the Currency last week told lenders to be more cautious about who gets these loans.

Seiders said he applauded the move to restrict these so-called "exotic" loans, adding that he believed that regulators were correct in "drawing attention to the risk."

"I hope it cools it down," he said, referring to the riskier versions of the loans.

If, however, the number of these loans is reduced substantially, fewer people may be able to buy homes in the Washington area, which would affect demand and prices.

Well, now, if the multitude of factors at play here makes it difficult to foretell the future, what can we learn from what we know about the past?

Over the past 40 years, ever since the Commerce Department has been tracking new-home sales, prices have risen, usually at a steady upward pace that exceeds the rate of inflation. The median-priced new home in 1963 cost $18,000, according to Commerce Department statistics, which is equivalent to about $109,944 in inflation-adjusted dollars. The median priced home in 2004, however, was more than double that amount, costing $221,000.

But values don't continually rise. According to the same statistics, the cost of a new median-priced home dropped 9 percent in the recession of 1970, falling from $25,600 in 1969 to $23,400 in 1970. And in 1991, during the savings and loan crisis, the median price of a new home dropped 2.4 percent, from $122,900 in 1990 to $120,000 in 1991.

So what does the future hold? Your guess is as good as mine.