The Ten Hottest Trends In the U.S. Housing Market

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The Ten Hottest Trends
In the U.S. Housing Market

By James R. Hagerty
From The Wall Street Journal Online

Conditions have been almost ideal for the housing industry in recent years.

Mortgage interest rates hit their lowest levels in more than four decades, making it much easier for Americans to buy houses. Many people who were burned in the stock-market bubble of the late 1990s decided that real estate was the best place to stash spare cash. The children of baby boomers began buying their first houses even as their parents started purchasing second homes or speculating on rental units. And American businesses finally began creating jobs again.

Home builders couldn't put up houses fast enough to keep up with all this demand. As a result, home prices are up by an average of 53% from five years ago, according to the closely watched index published by the Office of Federal Housing Enterprise Oversight.

Almost everyone agrees that prices can't keep rising this fast much longer. The debate now is whether the boom will lead to a soft landing, with gentler price increases, or to a long, painful bust, in which prices fall considerably in some places before buyers regain confidence.

However the current boom ends, longer-term forces are reshaping the housing industry. Here is a look at some of them.

1. SHORT ON SPACE

America still has lots of wide-open spaces, but many of them aren't where people want to live. And builders are finding it more difficult to get permits to put up new houses in many of the more economically vibrant metropolitan areas, particularly along the East and West coasts.

"The housing supply has been constrained by government regulation as opposed to fundamental geographic limitations," concludes a paper released in December 2004 by Edward L. Glaeser, an economics professor at Harvard University, and two colleagues.

Homeowners share the blame. Prof. Glaeser's paper says they have grown savvier about organizing themselves to block proposals that would bring new and more densely packed housing to their neighborhoods -- something that they fear could reduce the value of existing homes.

In the more crowded markets, home values no longer have much to do with the cost of building a home. In San Francisco, the paper estimates, the structure itself typically accounts for no more than 30% of a home's value; the rest of the value reflects the costs of land and obtaining regulatory approvals to build. That's why some people pay as much as $1 million for an old home, immediately tear it down and build a new one.

2. STRAINED BUDGETS

The housing boom has enriched many Americans by pushing up the values of their homes. But it hasn't been splendid for everyone. Nearly a third of American households spend more than 30% of their income on housing, and more than one in eight households spend more than 50%, according to the Joint Center for Housing Studies at Harvard University. Others move to distant suburbs so they can pay less for housing, but then must pay high costs to commute. A third of all households in the Boston area are at least 30 miles from the central business district, according to a Harvard study, and about a fifth live 40 or more miles out.

For people with modest incomes, housing has soared out of reach in some areas. The California Association of Realtors estimates that only 15% of households in that state earn enough to buy a median-priced home, currently costing about $544,000, without spending more than 30% of their income on mortgage payments, real-estate taxes and home insurance.

3. A SHRINKING FORECAST

For years, homes have been getting steadily bigger. The median size of new single-family homes in 2004 was 2,140 square feet, up from 1,535 square feet in 1975, according to the Census Bureau.

But some academics and industry people believe more Americans will embrace smaller, more urban homes, to avoid long commutes. James Z. Pugash, chief executive officer of Hearthstone Inc., San Rafael, Calif., which finances housing developments, predicts that American cities will become more like their European counterparts, with more midrise buildings, higher housing costs and fewer square feet per person.

In a 2004 paper for the Brookings Institution, Arthur C. Nelson, a professor at Virginia Tech, says there are at least tentative signs of growing demand for more "walkable" living environments combining homes, entertainment and offices. He cites as a model Arlington County, Va., near Washington. In 1990, Mr. Nelson writes, the conventional wisdom was that the county was "built out" and lacked space for more residents. Yet the population continues to grow rapidly. Mr. Nelson says the county is encouraging higher-density housing on former industrial sites and near mass-transit stations, while preserving the character of established neighborhoods.

The desire for more urban living -- and speculation that it will grow -- has spawned a boom in condominiums. In the 12 months ended in August, sales of condos and cooperative housing soared 14%, to a seasonally adjusted annual rate of 942,000 units. In the same period, sales of single-family homes rose a more modest 6.9%.

4. TAKING A RISK

As home prices have soared, lenders have promoted loans that help people afford houses that otherwise would be beyond their reach. These "affordability" loans hold down monthly payments in the early years but subject borrowers to the prospect of much higher payments later.

Among the most popular of these loans are interest-only mortgages, which allow borrowers to avoid paying down any of the principal in the first few years. Another twist is the payment-option loan, giving borrowers a choice of several payment levels each month, including one that is less than the interest due. If the borrower makes that choice, the loan balance increases, something known as negative amortization.

Lenders also have reduced the amount of documentation that many borrowers have to provide to verify their income and assets.

Bank regulators have started asking questions about all of these practices. The fear is that some borrowers have exaggerated their income or won't be able to meet the higher monthly payments once they come due. Another concern is that affordability loans have artificially pumped up housing prices by allowing people to bid more than they can really afford to pay in the long run.

5. THE HOME AS PIGGY BANK

The traditional goal of homeowners is to pay off the mortgage -- well before retirement, if possible. For now, many Americans seem to have forgotten that notion.

To take advantage of lower interest rates, Americans regularly refinance their loans. In the process of refinancing, they often borrow a bit more -- in effect swapping home equity for cash to spend on other things. Such "cash out" refinances totaled $139 billion in 2004, according to Harvard's Joint Center for Housing Studies. Egged on by lenders, other people take out separate home-equity loans, using their homes as collateral.

"I guess this generation believes that real-estate values will go up forever, so there's no need to pay down principal," said Angelo R. Mozilo, chief executive officer of Countrywide Financial Corp., the nation's largest mortgage lender, during a conference call with investors last year.

This blithe attitude has fueled consumer spending. A recent Federal Reserve study found that borrowing against home values added $600 billion to American consumers' spending power last year, or 7% of personal disposable income, up from 3% in 2000 and 1% in 1994.

6. FOREIGN FRENZY

The proliferation of riskier mortgage loans comes as foreign investors are playing a larger role in financing the U.S. housing market.

Investors in Asia and Europe have long been major buyers of debt issued by Fannie Mae and Freddie Mac, the two government-sponsored providers of mortgage financing. Now they also are buying an increasing amount of mortgage-backed securities, bonds backed by the payments of interest and principal on large pools of mortgages.

There are no reliable figures on the total size of foreign investments in U.S. mortgage securities, because many of the purchases are indirect, made through U.S. entities. But the direction is clear. Inside Mortgage Finance, a newsletter, estimates that foreign holdings of one type of mortgage bond -- those not guaranteed by Fannie or Freddie -- jumped to $40 billion as of June 30 from $30 billion six months earlier.

7. REDUCED-RATE REALTORS

The Internet hasn't slashed transaction costs in residential real estate, as it has in such areas as airline reservations. Commissions paid to agents still average more than 5% and sometimes reach 7% or more, according to industry estimates.

But brokers offering various cost-saving alternatives finally seem to be gaining traction. Many small brokers charge a flat fee, generally around $500, for putting a house into a multiple-listing service and providing a limited menu of other services; the consumer then typically offers to pay an additional 2.5% or 3% of the purchase price to any agent who supplies a buyer. Other brokers offer to rebate part of any commissions to the consumer.

Some traditional brokers are experimenting with their own discount arms, even as they try to preserve the full-commission business by backing state laws that mandate a minimum level of service.

U.S. antitrust enforcers at the Justice Department and Federal Trade Commission are putting heavy pressure on the industry to give new models a chance. For instance, the Justice Department in September sued the National Association of Realtors, alleging that its policy on sharing of listing information discriminates against brokers that mainly use Web sites to engage with their customers. The association denies that claim.

8. THE BIG GET BIGGER

Home building used to be mostly a local business, and there are still around 80,000 home builders in the country, most of them tiny. But the biggest builders are gobbling up more of the market. This year, the top 10 builders account for about 24% of the market (excluding homes built for customers on land they already own), up from 10% in 1997, says Ara K. Hovnanian, chief executive of Hovnanian Enterprises Inc., a large builder based in Red Bank, N.J. Within a decade, he predicts, that share will be more than 50%.

Big players have the upper hand partly because they have the financial resources to acquire prime parcels of land. Robert I. Toll, chief executive of Toll Brothers Inc., Horsham, Pa., says he often approves land purchases of $100 million or more, something small builders couldn't contemplate.

But Ivy Zelman, chief housing analyst at Credit Suisse First Boston in New York, says the big builders already have grabbed the easiest market-share gains in fast-growing metropolitan areas and now increasingly are butting heads with one another. That may make future market-share gains slower and more expensive.

9. GIMME MORE SHELTER

Americans have made so much money from their homes that they can't resist buying more real estate. Investment properties and vacation homes accounted for 14% of new mortgages last year, up from 7% in 2000, the Federal Reserve says.

Much of this buying comes from baby boomers seeking retirement homes or people hoping to strike it rich as landlords. While these purchases have helped to feed the recent strength in housing, they also could make the market more volatile. That's because second homes and rental properties, unlike primary residences, can easily be dumped onto the market if their owners lose confidence or fail to find reliable tenants.

10. WATCHING THE RANKINGS

J.D. Power & Associates, the consulting and research firm best known for its surveys of automobile quality, also quizzes buyers of new homes. The home surveys, which began in 1997, now cover 30 large metropolitan areas.

Companies that have done well in the surveys -- such as Pulte Homes Inc. and Centex Corp. -- are trumpeting the results. That's forcing other builders to try harder to score as well.

One problem for the industry is that it relies mainly on a continually changing cast of subcontractors to perform tasks like pouring foundations, installing heating ducts and shooting nails into roofing tiles. That makes it hard to ensure that quality standards are always met. Hovnanian Enterprises is experimenting with using its own employees to do more of the tasks in some markets in an effort to improve consistency.

Among other things, says Bruce Karatz, chief executive of KB Home, the surveys have nudged his company into communicating better with customers, including giving them earlier estimates of when houses will be completed. If KB is more than 30 days late, he says, "many customers will never forgive us."

Email your comments to rjeditor@dowjones.com.

-- November 22, 2005