Open-Ended Equations

By Tomoeh Murakami Tse
Washington Post Staff Writer
Thursday, April 20, 2006

Home buyers beware: The Washington region is now one of the most precarious real estate markets in the nation, according to reports by economists, banks and industry analysts.

But wait a minute. Maybe it's one of the safest, according to reports by other economists, banks and industry analysts.

PMI Mortgage Insurance Co. this month ranked Washington among the 20 riskiest housing markets. A Global Insight/National City analysis determined that housing over-valuation here is "extreme." And investment-banking firm Friedman Billings Ramsey Group Inc. of Arlington has identified the region as one of 69 around the country hosting real estate bubbles.

On the other hand, Credit Suisse First Boston LLC has declared the region "moderate and stable," assigning it a risk index of five out of a possible 10. And Washington is nowhere near the top of the list of risky places in's report, titled "Housing Correction or Crash."

So what's going on? Is the housing market here safe or not? How can Washington rank No. 9 on one bubble meter, No. 36 on another and No. 51 on still another?

The discrepancies arise because everyone has a different idea of how the health of the market should be measured. Dean Baker of the Center for Economic and Policy Research, who has been sounding the alarm on housing since 2002 and sees danger in this region, thinks calculating gaps in home price and rent increases is the best way to go. If they diverge too much, he says, a market is out of balance.

However, Michael Youngblood, author of the Friedman Billings report, thinks home prices and household income give the most statistically reliable picture.

Others prefer to come at the question from more angles. Many ingredients cook up a housing bubble, and they should all be taken into account, that thinking goes.

PMI, for instance, gauges several factors and their rates of change -- home prices, employment, household income and mortgage rates.

Mark Zandi of, meanwhile, weighs nine variables. Among them: interest rates, availability of developable land, job growth, demographics, construction costs and return on housing compared with other investments. While negative scores on one or two measures could be "explained away," Zandi said, it may be a good indicator of a problem if the location is red-flagged on multiple fronts.

Baker said he zeroed in on the long-term relationship between the housing and rental markets because of their strong correlation. High rents prompt tenants to buy; soaring home prices encourage landlords to sell. "They're the same market, at the end of the day," he said.

Measures such as land availability are useless indicators, he said, because properties can be redeveloped.

"Limited land has limited meaning," he said. "There's limited land for rentals, but it hasn't pushed up the rent."

Baker, with co-author David Rosnick, charted rent and home price increases from 1995 to 2005 and found that they have recently grown alarmingly out of whack in several cities.

Washington, along with San Diego, Los Angeles, Honolulu, Miami, San Francisco and Boston, made Baker and Rosnick's short list of places with the largest gaps between increases in rent and in home prices. Since 1997, Washington's home-price gain outpaced its rent increase by 50 percentage points, according to their report published late last year.

In the past, most places with big gaps subsequently saw home prices drop, often substantially. Homes in the New York area, for example, shed roughly a fifth of their value after the run-up in home price over rent hit 69 percentage points in the mid-1980s, the report said.

Youngblood, however, is skeptical of rankings based on rents and home prices. Rent data, he said, are derived from a pool of mostly multifamily dwellings, from which rents for all types of housing are extrapolated. Such a process, he said, is "replete with error."

Instead, he based his study on income data and home-sale figures from the Office of Federal Housing Enterprise Oversight, which tracks the same homes as they are resold and refinanced. Such high-quality data on housing prices, Youngblood said, already reflect factors such as interest rates and land-use restrictions. That eliminates the need to separately calculate those influences.

To complicate matters, the definition of the Washington region varies.

PMI, which ranked the region No. 18 on its risk index, tracked an area that includes the District, Arlington and Alexandria but excludes Bethesda. (The U.S. Census a few years ago broke out Bethesda and surrounding areas to reflect population growth.) Credit Suisse First Boston combines the two.

With analysts and economists disagreeing on the current state of the market, it is no wonder there is no consensus on its future, either.

Baker, the housing-market pessimist, said Washington home prices could very well drop by 25 percent.'s Zandi, who ranked Washington No. 36, says it is 32 percent overvalued. However, he said, that does not necessarily mean that prices will drop that much.

"There's different ways the market can adjust," said Zandi, a believer in the soft-landing scenario for housing. Prices could be flat, he said, "and the economy can catch up to it, or the market could fall 5 to 10 percent, trade sideways and let the economy catch up."

© 2006 The Washington Post Company