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Weaknesses Appear in the Housing Market

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Claude From NY

Senior Member
Jan 16, 2002
Professional Status
Certified Residential Appraiser
New York
After Long Boom, Weaknesses Appear in the Housing Market
Cracks are spreading in the foundation of the U.S. housing boom, as evidence mounts that the long run-up in home prices can't be sustained.

For the past several years, a rare confluence of factors -- including low interest rates, low unemployment, easy credit standards and tight housing supply -- have combined to stimulate an unprecedented surge in home sales, sending prices rocketing up. The result: housing has been one of the most important bulwarks of the U.S. economy, even as it gets buffeted by plunging stocks, business scandals and the war on terror.

But now some of the factors behind the housing boom show signs of fading, and indicators that traditionally foretell weakness in the market are emerging.

In more than 100 U.S. cities, home prices have climbed at least twice as fast as household incomes since 1998, according to data analyzed for The Wall Street Journal by the economic consulting firm Economy.com. Nationally, prices have risen at more than triple the rate of incomes in the last two years, a surge that is steadily putting home ownership out of the reach of more people. The nationwide price and income figures had tracked together closely through the 1990s boom.

Lengthy List

Though the problem is most common in the Northeast and on the West Coast, the list of localities with out-of-proportion prices includes large cities around the country such as Atlanta, Las Vegas, Denver, Houston, Tucson and Charleston, S.C. In Miami, home prices have shot up 58% since the beginning of 1998, while incomes have risen only 16%. In New York's Long Island suburbs, an 81% increase in home prices compares with a 14% rise in incomes. In Boston, home prices have jumped 89%, compared with income gains of only 22%.

And in some cities, including San Diego, Miami and Washington, the run-ups have accelerated in the past year -- confounding expectations that the market would cool off before it got too far out of line. In the late 1980s and early 1990s, the presence of such "bubblettes" in places such as Boston, Houston and Los Angeles signaled the end of a boom cycle. This time around, "the Boston area is still holding, and I don't know why," says Helen Babcock, manager of Carlson GMAC Real Estate in Winchester, Mass., a Boston suburb. "It's going to slow."

First-Time Buyers Hurt

All this is pricing first-time homebuyers out of the market in many areas of the country. That threatens a domino effect on demand for homes and suggests price appreciation must slow or reverse course until the market becomes affordable again. When the end comes, real estate isn't likely to deflate quickly, as technology stocks did, but even air seeping out slowly will have an impact on the broader economy.

"I have never seen an asset market -- whether it's stocks or real estate -- that has boomed to excessive prices ... without a serious downturn," says Allen Sinai, chief global economist of Decision Economics Inc., a forecasting firm. "I really doubt we will escape" without price corrections in some cities, he says. "Asset prices don't go straight up forever."

Sales are still headed for another record year, and low interest rates alone could keep propping up the market -- for as long as they last. But lenders are beginning to tighten credit for some high-risk borrowers, with mortgage delinquencies near their highest level in a decade and a record 1.23% of mortgages in the foreclosure process. Market observers say it's only a matter of time before lenders pull back further. "At some point, it has to happen," says Gary Gordon, a mortgage-banking analyst at UBS Warburg. "That would be one of the ways you could really get the big slowdown."

Meanwhile, job losses in many cities have piled up: Boston, for example, has shed 85,000 jobs since January 2001, while Seattle has lost 66,000. Speculative money that once went into the stock market increasingly has been flowing into the housing market and artificially pushing up prices. Such speculation is usually temporary and tends to presage a market peak.

Despite the recent run-ups in some cities, sales and prices of high-end homes in many places have slowed compared with a year ago. In Atlanta, a local forecasting group recently estimated a 21-month supply of homes priced at $500,000 and above. And homes are sitting on the market longer than before, as in affluent Collin County, north of Dallas, where listings have jumped 25% due to a flood of local job cuts. "Homes are just stacking up," says Bill Sabino, the managing broker at REMAX Preston Road North.

Inventory on Rise

Even the small inventory of housing, which has been a pivotal strength of the market, has gradually risen. Though still low enough to help cushion a correction, it has edged up from its all-time bottom in March 2000 when it would have taken just 3.9 months to sell every home if no more were built. Now that figure is at five months.

That leaves low interest rates as virtually the only undamaged pillar of the housing market. Low rates have endured longer, at lower levels, than almost any analysts expected, with average rates for 30-year fixed-rate loans now under 6%, the lowest since the 1960s. A turnaround in rates could have a dramatic effect in the opposite direction on prices. A half-point uptick would price two million more households out of median-priced homes, according to research by Sanford C. Bernstein & Co.

It's unlikely that a nationwide housing bubble would pop dramatically like the stock market, whose continuing bust has wiped out more than $7 trillion in investor wealth. While reliable price data only go back to the late 1960s, most economists agree there has not been a protracted period of falling home prices nationwide since the Great Depression, in part because real estate is such a local phenomenon.

While a nationwide bust is possible, it would probably require a market that is far more inflated across all parts of the country, coupled with far greater job losses or dramatically higher interest rates. Home-price gains remain in line with incomes in many cities, including Cincinnati, St. Louis, Kansas City and Columbus.

If job creation and income growth accelerate significantly, it's possible that home prices could slow slightly but keep growing until incomes -- and the broader economy -- catch up again. Some long-term trends for housing remain favorable, including land-development constraints that are making it harder for builders to add new homes, as well as continued new demand from immigrants.

A likely scenario if the housing market stalls, real-estate analysts say, would be a nation in which some areas continue growing modestly while other markets slowly deflate, rather than pop. That's because unlike stockholders, homeowners don't normally panic and run for the exits when trouble strikes. After all, they have to live somewhere. That can make home-price corrections more manageable, but also slower to unwind, than stock-market corrections. As long as the economy doesn't contract sharply and job losses don't accelerate significantly, "I think the 'going flat for a while' scenario is the right one" in most cities, says Karl "Chip" Case, an economist at Wellesley College and one of the country's leading authorities on housing bubbles.

Even a flat housing market could knock the wind out of the economy in some areas. Among other things, it would reduce homeowners' ability to tap rising equity in their homes though "cash out" refinancings that often depend on increased home values. Those refinancings have been a major source of consumer spending over the past year and a half. And the longer home prices keep rising faster than incomes, the greater the risk of even more painful local-market corrections becomes.

That puts the Federal Reserve, whose steps to reduce interest rates have helped fuel the recent price rises, in a tight bind. If down the road the Fed tries to curb inflation by raising rates, that could push housing prices down. If prices start to fall, consumer confidence in the economy would almost certainly wane, prompting shoppers to rein in spending. In a worst-case scenario, some homeowners could find themselves stranded in homes they cannot sell, as happened in the late 1980s and early 1990s in Texas, California, Massachusetts and New York, among other places.

That would almost certainly lead to more foreclosures, because it would make it impossible for families with strained balance sheets to sell their homes to get out of trouble, which in turn could lead to more credit-tightening, spurring a vicious cycle causing more price declines, as happened in the last downturn.

"You can see this being a pretty nasty scenario," says Robert Edelstein, professor of business administration and co-chairman of the Fisher Center for Real Estate and Urban Economics at the University of California at Berkeley.

The recent rises are all the more dramatic when compared with past bubblettes that popped, such as Boston's. During a five-year period ending in the late 1980s, home prices there rose 73%, while incomes grew 42%. That disparity -- far less dramatic than the current scenario in Boston -- turned out to be unsustainable when the local job market went sour amid a technology downturn at the end of the decade. Home prices fell 11% over about two years and didn't fully recover for about five years after that.

Similarly, home prices shot up 89% over a six-year period in Los Angeles in the late 1980s and early 1990s, while incomes grew 37%. The ensuing correction, spurred by a local recession driven by defense-industry cutbacks, knocked Los Angeles home prices down 24% over five years, and they took about four more years to fully recover. Other cities escaped unscathed at the same time -- in Chicago and Minneapolis, for instance, prices continued rising through the late 1980s and early 1990s.

Rising costs are especially important to first-time homebuyers, who in turn are especially important to the market. Without them, homeowners have little chance to profit on their homes and make the move-up purchases that represent the other part of the market. "If first-time homebuyers can't afford houses," says Chris Mayer, a professor of real estate at the Wharton School at the University of Pennsylvania, "then home prices fall."

That's bad news in San Diego, where Greta Cohn and her husband Dale Gill are itching to buy their first home. Together, the two earn about $62,000 a year, well above the median for the area of $48,300, and they have good credit. Their lender, Ms. Cohn says, has told them they can qualify for a loan of $160,000. But the median price of a house in San Diego has surged 75% since 1998 and 21% in the last year alone to reach $362,000, making just about every home in sight beyond their means. And the loan they qualified for was a no-down-payment mortgage, exactly the kind of loan some analysts believe will disappear from the market if credit conditions deteriorate.

"I've given up on the American Dream, at least for now," says Ms. Cohn, a 30-year-old nurse midwife with a master's degree and a 500-square-foot apartment. Now she and her husband are weighing another option: "Just rent for the rest of our lives and take great vacations."

Trouble in Concord

Mary Downes, 35, is running into the same problem in a normally quieter market: Concord, N.H., where home prices have been revved up by commuters who can't afford to live in Boston. Ms. Downes, an education director for a local nonprofit housing developer, figures she can afford a mortgage of $110,000. But most of the houses she finds are over $140,000.

"I torture myself and look on a Web site every now and then to see what's out there," she says.

The loss of such prospective buyers forces the market to be sustained by "move up" buyers who already own homes and are using the equity they've gained in recent years to make down payments on their next homes. But those who didn't buy in the past several years are winding up on the sidelines, leaving the market without an important source of new blood to keep sales strong over the next several years.

The national "affordability index," computed each month by the National Association of Realtors, nevertheless remains at very favorable levels: It now stands at 134.4, meaning that U.S. households with the median income can afford to purchase a home that is 34% more expensive than the median price. But that, some economists say, only demonstrates how dependent the market is on low interest rates, which are factored in to the index. When the affordability index is calculated just for first-time homebuyers, moreover, it comes in much lower: 76.9.

Another indicator that affordability is waning: Adjustable-rate mortgages, which help consumers offset rising costs by allowing them to get extremely low monthly payments for a short period of time, have increased to about 20% of the market from a recent low of 10% in the spring of 2001, according to the Federal Housing Finance Board. That indicates that some buyers are being forced to choose houses beyond their means, and can't afford the extra dollars for a fixed-term loan even though it provides the best long-term investment when rates are low. The large proportion of ARMs also means more risks if interest rates rise, making those owners' monthly payments more expensive.

Meanwhile, mortgage lenders, who have been making things easier for buyers, are poised to get tougher. Much of the current boom was made possible by huge changes in the mortgage business over the past decade, including the growth of Fannie Mae, the giant government-chartered company that buys loans from lenders to help improve the flow of capital through the home-loan market. Along the way, lenders began using computerized loan-approval systems that make it cheaper to process mortgages and easier to identify at-risk borrowers that deserve credit.

Lenders now require much smaller down payments than before, and they let buyers devote larger portions of their income to mortgage payments. Such innovations helped boost the homeownership rate to a record 68.1% last year from less than 64% in 1994.

In more recent quarters, however, the homeownership rate has begun to decline. It now stands at 67.6%. More importantly, lenders say many of the foreclosures and delinquencies are coming on their low-down payment loans and others that represent easier credit. And the Federal Housing Administration program, which insures loans primarily for first-time homebuyers, is seeing nearly 12% of its borrowers late on their loan payments, up from less than 11% a year ago.

Lenders have already started reining in some of their more ambitious programs. Some have been tightening the rules under which they will give loans to borrowers who can't fully document their incomes. Just last week, Fannie Mae said it would be raising fees for certain cash-out refinance mortgages after it determined the loans were defaulting more often than other mortgages.

It's also unclear how much more growth can be tapped from lower-income families that don't yet have homes. Down payments for first-time buyers are already low, averaging 6%, compared with 10% in 1989, and some economists question whether those figures can go much lower.

Anecdotal evidence from real-estate agents around the country suggests much of the demand for homes now is coming from speculators and investors who pulled money out of the stock market, rather than families who intend to hold on to their homes for years. "Flipping Properties," a guide to making money in real estate, recently cracked the Top 100 sellers on Amazon.com. While some of that demand is good for the market, it also pushes prices to unsustainable levels.

That's what some fear is happening in Lawrence, Mass., an industrial town about 30 to 45 minutes north of Boston that's home to a large population of Hispanic immigrants.

Miqueas Quinones, a nursing assistant who expects to make about $55,000 this year, has been looking to buy a house in Lawrence. Median home prices there have doubled since 1999, according to the Warren Group, a real-estate news publisher that compiles housing statistics in Massachusetts, but Mr. Quinones notes ruefully that to Boston investors that's still a bargain. "It's practically a war out there to get a house," says Mr. Quinones, who recently lost out to an out-of-town investor after bidding $270,000 for a 102-year-old property.

Lawrence has seen a boom and bust before. The median reached $135,000 in 1989, then crashed to $40,000 in 1994. Mr. Quinones's broker, Isabel Kianda of the Neighborhood Assistance Corporation of America, thinks Lawrence won't face anything that bad again, but she worries for customers such as Mr. Quinones. "It can't keep going up," she says. "Right now, I wouldn't be buying property as an investment."

Warning Signs

diagram from http://www.economy.com ommitted

Steve Owen

Elite Member
Jan 16, 2002
Professional Status
Certified General Appraiser
without price corrections in some cities

I've said before that the downturn, if and when it happens, will hit some areas and not others. In my community, prices have increased only modestly (in spite of the tax assessor's attempts to run things up using an AVM). I would like to think that part of the reason for the modest increase is good appraisers in our community who know a phoney value when they see one. It doesn't mean we can't turn down, just that we won't have as far to fall.

Meanwhile, job losses in many cities have piled up

I've also said before, that a deep, general recession will cause foreclosures regardless of whether the underlying property is overvalued. That, in turn, will lead to downward price pressure.

sales and prices of high-end homes in many places have slowed

This is the only segment of my market that seems to have been hurt, so far.

A turnaround in rates could have a dramatic effect in the opposite direction on prices.

Econ 101. Both I, and many other posters have mentioned this in other threads.

It's unlikely that a nationwide housing bubble would pop dramatically like the stock market

Unlikely under present economic conditions and future assumptions. Not impossible, however, just unlikely.

That would almost certainly lead to more foreclosures, because it would make it impossible for families with strained balance sheets to sell their homes to get out of trouble, which in turn could lead to more credit-tightening, spurring a vicious cycle causing more price declines, as happened in the last downturn.

As most of you know, this has happened before. Get out your calculators and prepare to be busy with REO's.

While some of that demand is good for the market, it also pushes prices to unsustainable levels.

And... also, is not possible without a crooked appraiser.

Good artilce, Claude. Thanks for posting it.
Jan 13, 2002
Professional Status
Retired Appraiser
Excellent article. What is missing is the prices that were inflated by Realtors and Mortgage Brokers using 'make whatever number you want' appraisers for sales and refinances. Way too many already owe more than the property is worth - they have no equity.

I'm now seeing 'cookie-cutter' subdivisions with sale prices all over the board with no rhyme or reason. This can only mean an inflated appraisal or maybe a skewed AVM was used.

Add this to that article........


Elite Member
Jan 22, 2002
Professional Status
Certified General Appraiser
Yes, the article is accurate - to a degree. The realtor cited in the Collin County area is correct - in a part of the submarket. Yet homes outside of where the telecom people are being laid off are selling and new custom home construction continues strong. Sales are slower as people are thinking twice about selling and moving. However, Denton County, which is next to Collin County is expected to jump in population from appx. 400,000 to 1.5 million over the next 15-20 years. Other counties are expected to follow suit due to the influx of people into the area. That means that (1) the downturn will be limited as the extra product is absorbed, and (2) prices will increase due to demand pressure.

The question then becomes, where are the people coming from? If the Dallas area and other sunbelt cities are experiencing an influx of population, it's not all from external immigration. It's also coming from other cities, which can create a loss in population and a continuing downward spiral in values and excess housing product. Some of the major New England cities are experiencing this now, i.e. Philadelphia and Pittsburgh. In these areas, there may not be an overall upturn. In some instances, it may well be that some of the product may have almost no value.

In other areas where extremist environmental and political groups have put in growth limits, artificially high prices exist and will continue to exist until some reality returns to the market. What may well happen in these areas is that business will realize that it's not economical to have a major company in these areas and relocate to more business-friendly communities. In today's market, except for a very few businesses, you don't have to be in a particular town. So a relocation to a state that wants more business, not less, can make economic sense. This will cause a reduction in high $ employment, starting the downward spiral in these aeas.

Just a few notes as to why there is not a National housing market. Apples and oranges, don't ya' know.

Stephen J. Vertin MAI

Senior Member
Jan 17, 2002
Professional Status
Certified General Appraiser
Why read the Wall Street Journal, everything said in the article has been said on this forum. And we heard it weeks in advance. Looks like the writer started reader some of these strings and decided to elaborate a little in certain areas.

Steve Vertin
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