What's Next for Real Estate?

We talked to two economists with starkly different views on the health of the housing market.

The will go down in the annals of history as one of the hottest real-estate markets ever.

From April 2004 to April 2005, home prices soared 15% nationwide, a gain not seen since 1980. In some local markets, particularly Southern California and Florida, the gains exceeded 30%. A record number of existing homes changed hands, and builders are on track to put up more homes than ever before, some 1.3 million units. This, of course, comes on the heels of a multiyear run-up that has exceeded every industry expert's expectations.

Was April the last gasp of speculative excess typically seen just before a crash, or a sign of a robust market that's in no immediate danger? Everyone from realtors in small towns across America to Federal Reserve Chairman Alan Greenspan has an opinion. Last week, Greenspan used the word "froth" in connection with some housing markets. "I think we're running into certain problems in certain localized areas," he said. "We do have characteristics of bubbles in certain areas, but not, as best I can judge, nationwide."

The comments reminded some of the first time Greenspan mentioned that the stock market was showing signs of irrational exuberance. Of course, that was in 1996, and the market went on to register three more years of outsize gains.

So which is it -- is the housing market on a delicate precipice or a solid foundation? We asked two economists for their take on the 2005 real estate market.

According to Dave Seiders, chief economist for the National Association of Home Builders, the underlying fundamentals of the real-estate market look healthy, and there are no signs of a slowdown in sight. Even if interest rates rise, as he expects, price appreciation will merely slow down, and prices won't decline on a national level. A bust, he argues, doesn't always follow a boom.

The Bullish Case
Dave Seiders
National Association of Home Builders
The Bearish Case
Dean Baker
Center for Economic and Policy Research
  • The long-term outlook for the real-estate market is positive. The economy appears healthy, the job market is improving, household income is growing and interest rates remain low. Underlying demand for housing is also quite strong thanks to immigration, low inventory levels and a limited amount of land supply.
  • If the economy behaves as I expect, interest rates for 30-year fixed-rate mortgages should climb to 6.25% by the end of the year. They're now around 5.7%. This modest rise should temper the housing market, and year-over-year appreciation should come in around 5% or 6% -- still a very healthy market.
  • A small proportion of past booms have ended in significant declines in some areas, but they were triggered by serious economic conditions, such as major job losses or the oil crisis of the 1970s. The only way the real-estate market could pop nationwide is if we had another recession. I don't see that happening this time. It feels like we're in the middle innings of an economic expansion.
  • Given the attractive financing conditions and the overall momentum in the market, first-time home buyers have very little to fear. Even if home prices were to dip slightly, they'd quickly reverse course and rise in future years. If you look back to Washington, D.C., in the early 1990s, prices did decline, but they recovered pretty quickly, and then went on another run higher. The long-term prospects are very good.
  • There's no rational explanation for the run-up in real estate. We're seeing classic bubble behavior, with people using exotic financial instruments that didn't exist 10 years ago. All you need is a modest rise in interest rates for people to get in trouble. And as long as home prices remain this high, builders are going to keep throwing more houses onto the market until there's oversupply and not enough demand.
  • I expect interest rates to rise eventually. Rates are the lowest they have been since the 1950s, and it's hard to see why. Even Alan Greenspan is surprised why they haven't ticked up higher. When mortgage rates climb higher, a lot of people are going to get burned. Even a modest increase will hurt those people who have interest-only and adjustable-rate mortgages, or who made small down payments. When, not if, the bubble bursts, prices could fall 15% to 20%.
  • Back in the early 1970s, there was a demographic shift -- baby boomers buying their first homes -- that fueled demand for housing. We don't have that this time around. Instead, the optimists try to make the argument that new immigrants and a change in how the rest of Americans value housing will keep feeding demand. I don't buy it. There just aren't that many immigrants, and how many of them do you know who are buying $400,000 homes? And if people were willing to spend more on housing because they valued it more than they used to, we would see that reflected in higher rents, too.
  • This isn't the time to enter the market. First-time home buyers should continue to rent unless they like throwing money in the garbage. Especially if you live in one of the really hot markets on the coasts. Prices have gotten so out of line in places like Washington, D.C., that prices could easily fall 15% to 20% or even 30%. First-time home buyers need to realize that they might not have the luxury of waiting out a down cycle in the market. A job situation changes, and you might have to sell your home and relocate. You could end up taking a loss on the property.