With Wall Street sagging and the rest of the economy looking soft this summer, are the still-spiralling prices being paid for new and resale homes totally out of touch with reality?

A number of gloom and doom analysts suggest that judgment day is just around the corner for home real estate, with prices at their peak before the inevitable crash. But many economists argue that housing prices--high as they may seem--actually reflect important underlying economic forces. Prices are not off the charts at all, they argue. They are simply being influenced by very different forces than those that govern the stock market.

Here’s their take on what’s really fuelling housing’s continuing vigor:

  • Home prices are moving up in tandem with household incomes, not outpacing them by a longshot. Despite the seeming disconnect between high housing prices and the overall economic slowdown, household incomes have in fact kept pace with housing prices. Data compiled by Standard and Poor’s chief economist, David Wyss, indicates that the prices of both new and resale homes relative to household disposable incomes are lower today than they were in the 1980s and 1990s. Whereas twenty years ago the average new home cost 3.1 times the average household’s annual disposable income, says Wyss, today’s prices average just 2.6 times. The key to this high household income growth: the rise of two-earner households, who now comprise the bulk of the home buying market. In earlier decades, single-earner households--Ozzie and Harriet-- were the norm. They couldn’t afford anything like today’s buyers can.
  • The cost of mortgage money--at near-record lows today--allows purchasers to afford far higher prices than they would have in the 1990s, 1980s and 1970s. According to Michael Carliner, staff vice president for economics at the National Association of Home Builders, the monthly principal and interest costs associated with the median-priced resale homes today represent 16 percent of household income. In the early 1990s, by contrast, that figure was 20 percent and in 1988 it was 23 percent.

    Anyone in real estate knows the maxim: Financing creates value. Low cost financing allows consumers to afford higher pricing, higher values. Remember what mortgage money used to cost? A lot of today’s buyers--and analysts--probably have forgotten. As recently as 1990, the averge annual rate for a new 30-year fixed rate loan was 10 percent. In 1981, the average annual rate was 16.6 percent. From 1979 through 1988, American home buyers paid an average annual interest rate above 10.3 percent.

    Today’s sharply lower minimum downpayment standards magnify the impact on values. Not only is money cheaper, but you need to bring less of it to the table to afford a new house. The result? You can afford to buy more house, at a higher price.

  • An often overlooked component of today’s towering prices: the remodelling boom of the 1990s. Low interest rates have encouraged homeowners to dramatically upgrade what they’ve got--pumping over $100 billion a year into family rooms, media rooms, giant new additions, luxury kitchens, bathrooms and the like. Resale houses in many area s with high appreciation rates are simply bigger, higher-quality and higher-amenity than they were just five years ago. So no wonder they sell for a lot more. They are worth a lot more.
  • A final factor: Federal tax policy. When Congress reformed capital gains taxation and eliminated taxes on most home sale profits, it set the stage for today’s high prices. Where else in the economy can you “overpay” for a capital asset, hold it for a few years, sell it, and then put up to $500,000 into your wallet, totally tax-free?


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