Last of the Red-Hot Markets
by Joe Light

December 13, 2007

[Continued, page 2]

Supply Side

If it's not demand pushing prices up, it's got to be you-know-what. One city where housing is tight: Portland, Ore., which has passed some of the most stringent growth restrictions in the country. The government limits new housing outside a 400-square-mile perimeter to encourage denser development in urban areas. Land costs have skyrocketed and developers have been slow to add housing. So despite the slide in national house prices, in Portland they appreciated by about 8% in the past year.

Portland's policies have been partly responsible for price run-ups in outlying towns like Longview, Wash. (pop. 35,000), says Glenn Crellin, director of the Washington Center for Real Estate Research. Once a sleepy town, Longview, an hour's drive from Portland, draws home buyers looking for lower prices. (The median price of a house there is $183,000, but $298,000 in Portland.) Prices shot up in Longview by 13.6% in the past year.

With tight supply and high demand, prices could have a tailwind indefinitely. A trio of economists—Joe Gyourko, Christopher Mayer and Todd Sinai—have argued that persistent growth in cities they dub "superstars" (for example, New York City and San Francisco) is fueled by a limited supply of housing and by a concentration of high-income families who are willing to pay top dollar to live there. True, both cities have hit bumps in the road in the past, and prices over the past year in the New York metro area rose by only 2.7% while in San Francisco they sank by about 1%. But, Gyourko says, "over the long term they will outstrip the national average."

The Madness of Crowds

Rampant speculation can also keep home prices burning. The frenzy starts, naturally enough, when economic growth increases housing prices and property owners profit big when they sell. More people buy houses or condos—by the dozen, figuring that they'll earn a bunch of quick bucks instead of just one. Real estate developers, seeing others profit, get in on the act by building thousands more homes. Eventually, speculators are merely selling to one another at ever more inflated prices. And when the last to buy or build can no longer flip those houses, prices plummet.

That's what happened in Miami and other South Florida towns where investors ran out of buyers who could afford to pay. At the height of the bubble, prices in Miami were rising by 3% to 4% a month. Now only about 10% of homes in Miami are affordable for residents earning the area's median income, according to the Housing Opportunity index, published by the National Association of Home Builders and Wells Fargo. (The index assumes that homeowners can spend about 28% of their income on housing.)

Bubble burstings occurred in other cities too. "Las Vegas saw tremendous appreciation during the boom," says Andrew Leventis, a senior economist with OFHEO. "Prices just got ahead of themselves." Affordability dropped to just 16% by mid-2006 and home values tanked, declining by 6%, according to Zillow.com, an online real estate appraisal service.

Housing in one hot market—San Antonio, where prices rose 10% in the past year and 40% in the past five years—is still fairly affordable. But it may soon go the way of Miami and Las Vegas. Between 25% and 29% of loans in the city in 2006 were for second homes or investments, according to Freddie Mac. "It suggests instability in the market," says Robert Shiller. "Prices could drop significantly."

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The opinions and views expressed in this publication are for general information only and are not necessarily those of Mutual of America Life Insurance Company.

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