May 26, 2005
Too many houses, too few households
Will demographics burst the house-price bubble? The Economist (paid subscription required) thinks so:
In the month of April, sales of existing homes rose 4.5% to a record 7.18m, at an annual rate, while prices soared. The cost of a median single-family home rose 15% in the year to April, topping $200,000 for the first time, while the price of a condominium went up 18%. These rates of increase haven’t been seen since the 1970s.
These trends are clearly not sustainable. For a start, the pace of home building is running far ahead of demography. As economists at Goldman Sachs point out, residential investment, at 5.75% of GDP, is at the top end of its range over the past four decades, while the trend growth rate in the number of new households being formed has slowed to 1%. Although the baby-boomers’ penchant for second homes explains part of the difference, it plays a small role. According to the Census Bureau, second homes account for only 5% of America’s housing stock. There are, as yet, few signs of oversupply—with housing inventory levels at near-record lows—but that may be a sign of speculative frenzy more than a real shortage of homes.
The magazine also points out that housing is now far more expensive relative to incomes:
Until the late 1990s median house prices were 2.75 times median income. That ratio has risen to 3.4. Arguably, lower mortgage rates justify some of this rise. But even if you look at mortgage payments in relation to household income, many people look stretched.
And, of course, they’re competing with speculators, who now account for one-fifth of mortgage originations in the frothiest markets. The banks, of course, are falling over themselves to service these buyers with instruments such as interest-only mortgages, which now make up about one-quarter of residential mortgage originations.
When house prices are rising, the banks always lend as much as possible to increase the value of their collateral. But when prices start to fall, the banks are usually among the first to run for cover—which will mean an even bigger bust.
Posted by Stephen at 3:57 PM in Economics | Permalink | TrackBack (0)
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