Home, Sweet Home
Check your water cooler or dinner party conversations. These days, everyone's talking about the soaring prices of residential property. The market is on steroids. Prices have been rising at the fastest rate in five decades, double digits in most markets: up by 27 percent last year in California, over 20 percent in Florida, 15 percent in New York, 35 percent in Nevada. Compare all this with the three-year average annual return in a typical diversified stock fund, which has been about 5 percent or so, and you know why people are all stoked about the home real-estate market.
It is all very reminiscent of the fever of the "new economy" stock market in the late 1990s. Today, housing has replaced tech stocks as the hot way to accumulate wealth for the some 70 percent of American families who own homes, the result of an 11 million increase in households that own their own homes since 1993. Given our low interest rates and the jump of about 50 percent in all home prices over the past five years, it has been possible for many Americans to turn their home ownership into cash machines, through equity loans or mortgage refinancing, at a time when the stock market has been languishing. Last year, Americans took out about $225 billion of their home equity, and even more in 2002 and 2003. Half of that was saved, and half was spent.
Rising home equity has propped up family net worth, leaving millions of Americans to feel they can afford to spend--hence the consumer spending that's buoying the economy. The appreciation of home prices is estimated to have been responsible for about a quarter of America's economic growth over the past four years--as well as about 70 percent of the increase in net household wealth. No wonder the number of people who think this is a good time to buy is at a 20-year high.
Speculation. The purchase of second homes made up a record 36 percent of all home purchases last year, according to the National Association of Realtors--13 percent for vacation use and 23 percent for investment. That's three times the percentages just five years ago. Reflecting increased speculation, existing homes are turning over 50 percent faster than the average of the previous decade.
Can the good news continue, or is this a bubble? Well, there are some signs of trouble. The increase in adjustable-rate mortgages is one. It means more people are stretching to keep up--and if rates rise quickly, buyers with relatively short adjustment periods may be forced to sell. Second, a lot of pent-up demand has already been satisfied. Third, prices have risen to levels that make homes much less affordable today. Fourth, interest rates are on the rise, increasing the costs of buying and owning real estate. Fifth, new-housing starts are slightly in excess of sales. All these raise the possibility of a slowdown in the market.
But there's also some good news. Average U.S. home prices haven't declined basically since the Great Depression, even though there have been regional setbacks. Housing prices dropped in the oil patch in the mid-1980s and in Silicon Valley after the dot-com bubble burst. The residential market often pauses after bursts like the ones we're now experiencing, so there's some vulnerability in areas where housing prices have risen extraordinarily fast, particularly if a downturn hits the local economies.
Nevertheless, people don't sell their homes as quickly as they do stocks, making any kind of sharp drop much less likely--especially given the tax advantages of homeownership and the continuation of remarkably low long-term interest rates. Furthermore, the good job and income growth we now have should support the current market. And there are all those between the ages of 30 and 44, who represent the prime market for new homes, particularly for second homes bought with an eye toward investment and retirement. And don't forget our unprecedented wave of immigration. That accounted for more than a third of our household formation in the past decade and explains the fact that 40 percent of new homeowners during the same period were minorities.
What we're seeing today is a re-enactment of a historic American homeowning tradition. Of course, homeowners who count on increasing their equity stake have to calculate that they need five years of residency at least before their mortgage payments can get past the point where they are mostly for interest. But that's very similar to the traditional period for building an equity stake in most investments.
When America expanded from its coastal fringe, the government encouraged settlement by offering 160 acres that a homesteader could purchase by working the land for five years. It was the single most important stimulus for building a new nation of property owners. Today, homeownership has become the single most important element in the widest participation in an era of rising wealth. This is an ownership society for real.
This story appears in the May 16, 2005 print edition of U.S. News & World Report.