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Housing boom to outlast another decade - a US perspective

Guest perspective: Wealth, immigration trump loan delinquencies, affordability hurdles
Tuesday, July 01, 2003

By Kermit Baker

Housing is well-positioned for another solid decade when the economy regains momentum and the lingering effects of the recession subside. Average incomes and wealth for all age groups are higher today than they were 10 years ago. These gains, together with continued strong immigration, should put household growth and housing investment above 1990s levels. At the same time though, escalating costs will make it even more difficult for low- and moderate-income households, whose incomes grow more slowly, to find affordable homes.

By most measures 2002 was the strongest year for housing on record, despite the 2001 recession and weak ensuing recovery. Residential investment, home sales, home ownership rates and home prices all improved last year. But anemic overall economic growth has nevertheless taken its toll, sending mortgage delinquency rates up while pushing down rents in some areas.

Rising home values and falling interest rates gave housing a sturdy boost in 2002. Home ownership rates, investment in new construction, home sales, remodeling expenditures, home equity and mortgage refinance volumes all hit new highs, even in the face of widespread job losses.

With rates at 40-year lows, record numbers of homeowners rushed to refinance their mortgages and cash out some of their newfound housing wealth in the process. All told, refinancing pumped an estimated $110 billion in home equity back into the economy with another $70 billion going to pay off higher-cost second mortgages. Low interest rates also encouraged homeowners to replace higher-cost consumer credit with equity loans or lines of credit, expanding net second mortgage debt by about $130 billion.

The number of new single-family homes built in 2002 reached the highest level since 1978, as multifamily production increased slightly. The only weak spot in production was manufactured housing, which still struggled to work off excess inventories. Home building has kept pace with long-run demand, although residential construction was unusually strong for a period of such paltry economic growth. Barring a slide back into recession, residential construction should remain strong in the years ahead. With little pent-up demand in evidence though, housing is unlikely to lead the economy into more vigorous growth.

Surging home prices have sparked fears of a housing market collapse; however, widespread price declines are unlikely because home prices in most areas have increased in line with income growth. History demonstrates that few areas experience the kind of concentrated job losses that precipitate severe home price deflation.

Over the past 15 years, 53 of the 100 largest metropolitan areas have not experienced a single year of declining nominal home prices. Most areas, in contrast, have experienced slow deflation in real (i.e., inflation-adjusted) home prices after prolonged run-ups. In fact, real prices in 58 of the largest metros have fallen at least 10 percent at least once since 1987. In about a third of these locations, however, the real home values of owners who bought at least two years before the peak exceeded their purchase prices even at the bottom of the inflation-adjusted declines.

Despite this remarkable buoyancy, housing market risks have intensified over the past few years. Job losses have forced more mortgage holders into foreclosure, increased the number of homeowners spending half or more of their income on housing and softened some rental markets. Expansion of mortgage credit to borrowers with past payment problems has elevated foreclosure risks. Increased mortgage-debt levels and growing shares of home buyers with high loan-to-value ratios have raised concerns about the amount of debt carried.

Though heightened, several of these risks remain relatively well contained. The increase in mortgage debt has yet to create serious problems. Thanks to lower interest rates, owners have been able to increase their debt loads without necessarily adding to their monthly payments. Strong home-price appreciation has increased home values, providing 88 percent of mortgage borrowers with equity of 20 percent or more in 2001. Only about 4 percent of mortgage borrowers had equity of less than 5 percent in that year.

Although economic and geopolitical uncertainties cloud the near-term outlook, the underpinnings are in place to support another strong decade for housing. Household growth, the primary driver of housing demand, may well exceed 12 million between 2000 and 2010. Immigrants are expected to contribute more than one-quarter of this increase and minorities fully two-thirds. The growing influence of minorities on housing markets was evident in 2001, when minorities accounted for 32 percent of recent first-time buyers and 42 percent of all renters.

Shifts in the age distribution of the population will favor higher spending on both remodeling of existing homes and purchasing of new homes in the coming years. By 2010, older baby boomers will be in their peak wealth years, and younger boomers will be in the peak-earning ages of 45 to 54. The boomers will still be an important force in home-buying markets because of their sheer numbers and economic clout, even though fewer of them will move during the next 10 years.

The younger, more mobile baby-bust generation also will be important to housing markets as they continue to form new households. The echo boomers will be starting to reach young adulthood and living on their own, boosting demand for apartments and starter homes.

Household growth is likely to remain concentrated in Western and Southern states, but most of the large metropolitan areas across the country will see strong housing production at the fringes. Just as white households continue to move to these outlying areas, minorities are now moving out of the traditional city cores to the inner suburbs. Over the next decade, immigrants are expected to fan out from the handful of metro areas that are traditional gateways for foreign-born households.

And yet affordability pressures have intensified. Even households with incomes well above the full-time equivalent of the minimum wage are struggling to find housing that meets their needs at costs they can afford. Between 1997 and 2001, the number of lower-middle and middle-income households spending more than half their incomes on housing surged by more than 700,000.

For households with the lowest incomes, the only answer is subsidies that defray their housing costs while still providing enough funds for adequate property upkeep. As it is, many of the nation's 21.4 million neediest households can barely afford to cover the cost of utilities, property taxes and maintenance on even modest units in less desirable communities. Today only 32 percent of these neediest renters receive assistance, and with government deficits ballooning, the prospects for expanding this share are grim.

The already scarce supply of smaller, less costly housing is shrinking, with especially sharp losses among two- to four-unit apartment buildings. Regulatory and natural constraints on land are driving up land costs in and around many of the nation's metropolitan areas, restricting development of affordable housing. The hope remains though that communities will begin to find ways to balance the need for a mix of housing types suitable for a range of incomes with community interests in improving environmental and housing quality.

Kermit Baker is chief economist of the American Institute of Architects and a senior research fellow at the Harvard University Joint Center for Housing Studies.

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