House prices, numbers of non-occupying home buyers, and home sales all set records in 2004, but higher short-term interest rates and the strongest one-year price appreciation since 1979 are a warning. When first-time home buyers have difficulty breaking into the housing market, with low-wage jobs increasing and other jobs stagnating, affordability problems will persist, says the Joint Center For Housing Studies Of Harvard University in its annual "State Of Nation's Housing: 2005" report.

In 2004, consumers chased low interest, hybrid, and other favorable loan products and rates boosting homeownership to an all-time high of 69 percent. House price gains, responding to consumer demand," sparked near-record cash-out refinances and record home equity borrowing.

The housing boom has lasted for an unprecedented 13 years, eight years longer than the last expansion of 1970. New home starts relative to the pace of home sales is at the lowest level ever, says the report, and would have to retreat by a third for over a year before creating a buyer's market.

But cause for concern persists, cautions the report. "Clearly, ratios of house prices to median household incomes are up sharply and now stand at a 25-year high in more than half of evaluated metro areas," a number that has tripled from 10 to 33 in the last five years. Seventy-seven of the 110 evaluated metros had prices that were more in line with incomes and therefore more affordable.

Sharp corrections in "hot" markets could be avoided by the current economic recovery, but the report also notes that the share of home purchase loans by non-owner-occupants grew in 2004 from 7 to 11 percent. Subprime loans gave millions with blemished credit records, who would previously have been denied a loan, the chance to buy a home. Meanwhile, interest-only and adjustable rate loans are helping blunt the impact of higher home prices. Indeed, adjustable rate mortgages accounted for more than a third of all mortgage loans last year and interest-only loans for nearly one-quarter.

"The irony of today's housing market is that while fundamentals are supporting record levels in residential investments, housing affordability problems are climbing the income scale," states Nicolas P. Retsinas, director of Harvard's Joint Center for Housing Studies.

The report cautions that creative financing is adding to the risk of homebuying. "Although interest-only and adjustable loans can initially save a typical home buyer hundreds of dollars in monthly payments, these loans also leave borrowers vulnerable to sharply higher payments when interest rates adjust or principal payments start to become due," warns the report.

"With the number of borrowers vulnerable to payment shocks up, default rates predictably several times higher for subprime than prime loans, and house prices growing at such rapid rates, the housing market could deteriorate if the economy softens or if rates increase sharply," explains Retsinas.

Payment shocks for most owners are still several years out, says the report, and many will sell their homes or refinance before they face these shocks. However, short-term risks of price declines and rising defaults will likely remain low if the economy continues to expand. When the economy hits a soft spot, though, housing corrections may be more painful than they would otherwise have been.

Long-term, the report finds reason to believe that residential investment will reach new heights again over the next ten years. Strong levels of immigration are bolstering household growth and productivity gains are driving increases in real incomes. The baby boom generation is reaching their mid 40s to early 60s with record income and wealth. This will lift the demand especially for second homes, homes marketed to seniors, and large remodeling projects. Meanwhile, the entrance of the children of the baby boomers into young adulthood will lift rental and starter home demand.

But the party isn't going to be fun for everyone.

"While the future looks bright for housing investment, there is little cause for optimism that the nation's housing affordability challenges will diminish; in fact they are growing worse," notes the Center's Executive Director Eric Belsky.

Between 2000 and 2003 alone, the numbers of households spending more than half of their income on housing increased by 2.5 million. "Housing affordability is a chronic problem and narrowing the gap between what decent housing costs and what low-wage workers and retirees can afford will remain a major national challenge."

Households are increasingly taking longer, more costly commutes to lower housing costs (causing sprawl and deteriorating inner cities). Nationally the number of workers taking commutes of an hour or more surged by 3.1 million in the 1990s. "Up and down the income scale, spending less on housing typically means spending more time and money on the road," says the report.

Harvard's Joint Center for Housing Studies is the nation's leading center for information and research on housing in the United States. Established in 1959, the Joint Center is a collaborative unit affiliated with the Harvard Design School and the Kennedy School of Government. The Director of the Joint Center for Housing Studies is Nicolas P. Retsinas. The Center's research and additional information about its programs and activities are available at Harvard's Joint Center for Housing.

Published: June 14, 2005

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