Clear skies ahead for home values

You know what happens if you blow a piece of bubble gum to the breaking point. As house prices keep expanding, many buyers wonder whether they'll end up with the investment equivalent of that sticky pink mess.

And who can blame them? Ever since the stock market took its three-year swan dive, Americans have shied away from markets that seem too good to be true. But real estate doesn't look like a bubble about to burst, many experts say.

Population growth, economic recovery, and reforms in the construction industry are likely to keep fueling the real estate market. True, a rise in interest rates is expected to dampen price increases in the next few years. But mortgage holders face more danger from individual circumstances - too much debt or not locking in low mortgage rates - than from the threat of a national housing downturn.

"In the late 1980s, there was a lot of speculation: People were buying housing stock, speculating on future returns, and selling it," says Perry Wong, a senior economist at the Milken Institute in Santa Monica, Calif. "This time is very different. People converted their assets into real estate because they didn't see a stable stock market."

Americans perceive residential real estate as the "new gold" - a store of stable wealth - at a time when stock markets are volatile, says one housing expert. Average national home prices have risen every year since at least 1950. Although prices are notoriously volatile in some metropolitan markets, and there's always a chance you'll get caught wanting to sell your house during a temporary dip, the last example of a clear-cut national housing bust was probably the Depression, says Doug Duncan, chief economist at the Mortgage Bankers Association in Washington.

This year looks good because of the prospects for job gains and continued low interest rates. The National Association of Realtors expects a 4.4 percent gain in median prices for existing homes ($177,400) and new homes ($202,900). That's not as big as the 7.5 percent gain in 2003. But moderate price appreciation could last a long time as population growth boosts demand.

Some 12 million new households will have formed in the United States between 2000 and 2010, according to a report last fall by Harvard University's Joint Center for Housing Studies.

Also, income growth has generally kept pace with rising home values. Between 1991 and 2001, US averages for both grew between 4 and 5 percent, the Harvard report shows. While home prices now outpace income growth in many metro areas, "it will probably all come back into line," says Allegra Calder, project manager for the report.

Even in some markets with the highest prices - where fears of a bubble are most common - demand tends to stay strong, experts say. Coastal cities such as Boston, Washington, and San Francisco, for instance, draw people because of their cultural, educational, and outdoor amenities. When Internet stocks bombed, "San Francisco saw a 25 percent decline in house prices over the course of a year," Mr. Duncan says, "but there was a group of people sitting out in the suburbs who said, 'Well, we've always wanted to live in San Francisco, so this is probably the time to buy' - and prices were back up the next year."

The housing market can be volatile, Duncan says, but a bubble is unlikely because most home purchases aren't driven by speculation. Investors who don't intend to live in the properties they buy make up less than 3 percent of the housing markets he's examined.

On the coasts and in other key immigration areas such as Texas and Arizona, population projections also suggest demand will stay strong well into the future, economist Wong says.

The outlook is also good on the supply side. The building industry was hurt in the 1980s when it oversupplied the market. But now it's much more conservative, often selling homes before they are built. Plus, in many areas, local zoning makes it difficult for builders to add new developments.

That doesn't mean a national decline is out of the question, some experts warn. "People can't remember when housing prices actually fell ... so they think their downward risk is zero," says Stephen Thode, a finance professor at Lehigh University in Bethlehem, Pa.

Accounting for inflation, there have been periods when average US home values have fallen. An International Monetary Fund report found five such busts - when real prices fell at least 14 percent - since 1970, says Christopher Mayer, vice president of Provident Bank in Gaithersburg, Md.

Mr. Mayer worries about scenarios that could cause more such busts in the future. For example, if the construction industry forgets the lesson of the '80s, it might overbuild again. Builders can find ways to develop properties in dense and urbanized areas by razing old homes or industrial properties, he says. And communities have at times changed zoning rules to fit in more housing per acre.

Any shocks to the economy - such as 10 to 15 percent unemployment or another speculative shift from stocks into real estate - could also lead to broad declines, Duncan says, though he doesn't see these on the horizon.

In the near future, everyone's watching interest rates. A sudden large increase "could really come down on the market and people might just start to panic," Wong says. But he and others say a gradual increase is much more likely, giving people time to adjust.

Homeowners with large mortgages face the greatest risks. For those with 20 percent equity in their homes, for example, a 10 percent decline in value would mean a 50 percent loss of equity, Mayer indicates. Because so many families rely on two incomes and carry high debt loads, "the ability of the average American consumer to take a setback is much less than it once was," he says.

Especially vulnerable to rising interest rates are homeowners with adjustable-rate mortgages. In 2003, 19 percent of borrowers opted for ARMs, which rise or fall according to interest rates. That's down from a peak of 39 percent in 1994, but the Mortgage Bankers Association predicts the figure will climb to 23 percent this year.

The high end of the market is what worries Mr. Thode. Many baby boomers with huge houses today may find it difficult to resell if they decide to downsize. "Presumably they will sell them to 'echo boomers,' people their children's age," he says, but those echo boomers may be shelling out so much for Social Security and Medicare taxes that there's not enough left over.

Does that mean you shouldn't buy a house? Even many skeptics aren't willing to go that far, especially since homeownership represents far more than simply an investment. "A lot of quality-of-life issues are associated with that, like schooling and commuting," Mayer says. But keep in mind "you are buying at what has to be somewhere near a peak right now. [Housing appreciation] could go for a few more years. When it will end is the key question that no one can really answer," he says.

Housing is an inherently utilitarian investment, says Stephen Roulac, a consultant in San Francisco who is bullish on real estate. His analysis of economic factors and social patterns in which people are cherishing time at home more indicates the housing market is undervalued by roughly 20 percent. "Absent a shock to the system," Mr. Roulac says, "[prices] will still go up."