The start of a new year is always a benchmark of sorts, an opportunity to see where we've been and perhaps where we're going.

There's little doubt that 2004 was very good for real estate. Interest rates for 30-year fixed-rate loans hovered between 5.4 and 6.3 percent for much of the year, not reaching the absolute low of 5.21 percent plus .5 points seen in June 2003 but a range which was positively wondrous by the standards of the past 40 years.

Low rates led to strong sales in 2004 for both existing and new homes. The National Association of Realtors estimates that existing home sales will reach 6.58 million units in 2004, up 7.9 percent from 2003 and a record.

Existing home prices were also expected to rise 7.9 percent to $182,500 in 2004, says NAR. Given low inflation levels, the projected $13,362 value increase means that most homeowners have additional real wealth as a result of rising home prices.

David Seiders, chief economist with the National Association of Home Builders says that "sales of new single-family homes will hit a record in 2004 despite the surprising decline reported for November." New-home sales for the year will be somewhere in the 1.2 million range.

The huge sales bulge has been great for real estate brokers and mortgage lenders. More transactions mean more opportunities to sell brokerage services and to originate new loans. No less important, real estate transactions are a substantial part of the overall economy -- what's good for real estate is literally good for hardware stores, furniture producers, shopping malls, and just about everyone else.

What will happen in 2005 is surely unknown at this moment, despite claims to the contrary by fortune tellers, psychics, economists and Wall Street analysts. What we do know is that interest rates are the key factor to watch.

Most homes are financed in whole or in part which means that buyer choices are profoundly influenced by mortgage interest rates. Low is better but there is little doubt that rates will rise in 2005 as a result of federal deficits, a dollar devalued because of balance-of-trade shortages and rising oil costs. The question then is not whether rates will rise but how much.

Today, for example, a $300,000 mortgage at 5.75 percent over 30 years produces a monthly cost for principle and interest of $1,751. Raise the rate to 6.75 percent -- still low by the standards of the past few decades -- and the cost escalates to $1,946. Seen another way, if $1,751 was affordable at 5.75 percent, at 6.75 percent the same monthly payment can only finance $269,967 in mortgage debt -- a 10 percent drop from $300,000.

Higher mortgage costs can be overcome by rising incomes. However, if incomes remain largely static then it will be difficult to maintain the surge of rising home prices seen during the past year.

Could we see a drop in existing home values? That's already the case in such areas as Dallas, Indianapolis, and Louisville according to a third-quarter metro report from NAR. However, these results are not typical. Of 127 metro areas measured by NAR, only 11 were down while 45 had double-digit price increases.

Would it be a terrible thing if home values failed to rise as quickly as they did in 2004 or if values in some communities actually fell?

Those seeking to refinance as well as short-term owners would be immediately impacted by lower prices. Those with adjustable-rate mortgages (ARMs) could expect to see higher monthly costs.

However, most homes are owned for a lengthy period, perhaps eight to 10 years -- an average which would likely become longer in the face of a rate rise because owners would not want to give up the fixed-rate loans acquired during the past few years. In effect those who have financed with fixed-rate loans, expect to hold their properties and have no interest in refinancing will be largely immune to short-term price drops.

The movement of ARM rates in the past year suggests caution. As examples, the 6-month LIBOR index more than doubled from 1.2107 in January to 2.6239 in November. Even the staid, slow 11th District COFI -- another popular ARM index -- moved from an announced rate of 1.811 at the start of the year to 1.960 as of November 30th.

There are substantial unknowns for the coming year: What will happen in Iraq? Will federal tax policies change? Will oil prices rise? Will employment levels hold?

Stay tuned -- to bend an old expression, we are about to live in interesting times.

For more articles by Peter G. Miller, please press here.

Published: January 4, 2005

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