Why real estate values may hold up in a recession

With the economy in a slump, David Lereah has a comforting word for the 68 percent of householders who own their own homes.

Through recessions and all, home sales may have been off from time to time, but home prices, on average, have "never turned down," across the United States, says the chief economist of the National Association of Realtors (NAR) in Washington. They tended to rise 3 to 5 percent a year, usually above inflation, in the postwar era.

Prices are influenced by sales activity. In September, with the terrorist disaster tying buyers to their TV sets, sales of existing homes plunged 11.7 percent. Sales of new homes fell a little. But housing starts made a surprising gain.

Despite the current economic downturn, Dr. Lereah expects house prices to keep rising, if more slowly. "Housing markets are in a much better position than in previous recessions," he says. "The supply of homes is relatively lean. There is no overbuilding out there."

The NAR represents 802,000 real estate agents in the nation, people whose livelihood generally benefits from rising house prices.

A. Gary Shilling, an economic analyst in Springfield, N.J., isn't so bullish on housing. He calls such industry economists as Lereah, "paid cheerleaders."

Dr. Shilling has long been predicting a period of deflation in the US. Prices in general would go down, not up. If that occurs, house prices could slip after "a lag of a couple of years."

So far, though, Shilling's forecast hasn't panned out. And most economists don't buy it for this year or next year.

Shilling has another observation: Houses have become bigger in recent years, with more bathrooms, fancier kitchens, better wiring, more air conditioning, and two-car garages.

If that extra house quality is taken into account, the average home price across the country, in constant dollars, peaked in 1979 at about $124,000. It was $111,000 last year, up from a trough of $105,000 in 1992.

That doesn't mean that homeowners haven't had a good deal. To the contrary, houses are "a great investment," says Karl Case, an economist at Wellesley College, Wellesley, Mass.

For one thing, homeowners have a place to hang their hats rent-free. From an economist's standpoint, the home is providing a rent equivalent, minus the costs of maintenance, taxes, etc.

Second, the homeowner usually has a highly leveraged investment that makes a sizable capital gain whenever its value rises faster than inflation.

Shilling gives an extreme example. A homeowner puts 20 percent down on a house, has a mortgage with 10 percent interest, and the price rises 15 percent in one year. (Prices actually have done so in some housing markets, such as the San Francisco and Boston areas.)

In that scenario, the homeowner would have made 35 percent on his or her investment that year.

If house prices do decline, the leverage works the other way. And home prices have at times fallen dramatically in specific areas (1989-90 in New England, 1987-88 in Texas, and 1990-91 in California).

Professor Case sees home prices now as "vulnerable" to the bursting of the Internet bubble in San Francisco, the financial-industry troubles in New York, and to tech slowdowns in such areas as Boston and Dallas.

But it's not as bad as a dozen years ago, when prices of some condominiums in the Boston area fell 30 percent.

Large, expensive homes are already being hit by the apparent recession.

"Home prices are likely at best to stabilize over the next couple of years," says Michael Cosgrove, an economist at the University of Dallas business school. While more unemployment depresses prices, low interest rates boost the affordability of houses to many people.

Unlike commodity prices, house prices change slowly.

Unless forced to by the loss of a job or other circumstances, most owners won't sell at a price much lower than they expect.

"They hold out," says Karl Case, "They won't sell for a while."

"There is a good chance of coming out of this recession without a great deal of deflation in the housing market," concludes Case. "But hold onto your seats."

Of course, if the economy sank into a deep and prolonged recession - one not forecast by most economists - house prices could tumble sharply.

For most Americans, their homes are their largest source of wealth. A new survey by the NAR finds the typical homeowner has about $50,000 in unrealized capital gains. Those surveyed who were at least 50 years old had a median equity of $80,000.

Three out of 4 said their home wealth is greater than their stock wealth.

Moreover, many homeowners have been making use of the equity in their homes, adding to the nation's prosperity in recent years. "The wealth effect from housing is larger than that from the stock market," says Lereah.