Brace for a Slowdown, Not a Meltdown, in Housing Prices
A cooling. A simmering down. A deflating. A hissing sound. Economists continue to churn out inventive terms for what they see the housing market doing this year.
Despite the different turns of phrase, they tend to agree: After several red-hot years, the housing market will slow significantly in 2006. But it won't pop like a bubble either. Home construction, sales, and prices will still be strong--very possibly the second-best year ever in terms of sales--but nowhere near the frenzied pace of last year, when sales of new and existing homes posted all-time records.
"It's probably pretty credible to think that 2005 was the peak for this housing cycle," says Bob Curran, Fitch Ratings' home-building analyst. That said, "we don't see home prices declining nationally or even regionally--perhaps in an isolated market here or there," adds Curran, who expects 2006 to be the start of a one-to-two-year down cycle in housing.
That means the balance will tip from sellers to buyers as the number of homes on the market rises. "Sellers have dominated metropolitan markets for several years now, setting their price and getting it," says David Lereah, chief economist at the National Association of Realtors. "But buyers are beginning to say no to that, and eventually sellers are going to have to revise their prices downward."
Several of the factors that boosted the 2005 market into the stratosphere--historically low mortgage rates, lenders pushing exotic mortgage products such as interest-only loans, and the presence of speculators in certain markets--will most likely abate this year, according to David Seiders, chief economist at the National Association of Home Builders. He predicts housing starts will fall nearly 6 percent this year from 2005; single-family-home starts will fall 7.5 percent; and new-home sales will drop 6.5 percent. Home price appreciation, which reached an unbelievable pace of nearly 11 percent in 2005, will be cut almost in half to a more modest 6.5 percent this year and 4.4 percent in 2007.
Adjustment. Unlike Fitch's Curran, Seiders doesn't think this housing market has peaked. "I look at 2006 as an adjustment to more normal levels, not a cyclical downswing," he says.
What's behind the slowdown is the simple fact that prices have reached levels that many cannot afford. NAHB's housing affordability index for the third quarter of 2005 fell to its lowest level since the index debuted in 1992. Entry-level-home sales will probably suffer the most, says Curran, as first-time buyers are turned away by high home prices, rising mortgage rates, and tighter lending standards.
The other end of the spectrum should suffer too, but for a different reason. Those shopping for a luxury home will still be able to afford the one they want, but they may delay a purchase because of consumer confidence issues, says Curran. In December, Toll Brothers, one of the nation's largest luxury home builders, warned that softening demand might make its 2006 profits fall short of Wall Street expectations.
Not surprisingly, the regions that heated up the most rapidly are expected to cool off quickly, too. That means the West (California in particular), northeastern markets like the Boston, New York, and Washington metropolitan areas, and Florida. Inland hot spots--Nevada and Arizona are a couple--will also fall off more dramatically than the rest of the nation.
In affluent Montgomery County, Md., near Washington, the market is still perky, says Meg Finn, a Long & Foster agent. She's expecting a bit of a slowdown in 2006: "Maybe not as crazy as last year, but that would be OK," she says. Right now, the only signs Finn sees of a cooling housing market are at the lower end. The average price of homes sold by her office is nearly $600,000, says Finn. "I'd like to see a house take a week to sell instead of three days so people could catch their breath and maybe even get a home inspection," she says.
Status quo. Prices in many markets between the coasts never rose that quickly, so the chances of a bust there are minimal. In Hamilton County, Ind., just north of Indianapolis, home sales are strong and should remain so through the year, says Deb Castino, a real-estate agent with F.C. Tucker Co. in Noblesville. Her office had a record 2005, but that meant sales were just 2 percent better than in 2004. "It was never like California, where you put a sign in the yard and get six offers in 10 minutes," says Castino. Homes in Hamilton have been selling right around list price--the average is about $250,000--and have been staying on the market 70 days or so on average. Castino and her colleagues dismiss all the talk they hear from the coasts about a real-estate bubble bursting. "We expect about the status quo this year," she says.
Castino is seeing some buyers come to the area from other parts of the country where homes are much more expensive, such as Arizona and Florida. They're attracted to Hamilton County for the good schools and the fact that they can get a lot more for their money, she says.
For those selling their house and buying another, NAR economist Lereah says moving to a place like Hamilton is probably the only real way to cash in on the transformation of a seller's to a buyer's market. For people staying in the same market, he says, it will be a wash.
This story appears in the January 16, 2006 print edition of U.S. News & World Report.