Commercial PropertyWhat Drives Housing Booms and Busts?
U.S. home prices have boomed in recent years, rising 13 percent in the year ending September 2004, and up almost 50 percent over the last five years.
In light of five-year growth in which housing has risen almost 50 percent, surpassing any increase in the last 25 years, a recent Federal Deposit Insurance Corporation (FDIC) report entitled "U.S. Home Prices: Does Bust Always Follow Boom?" questions what causes housing booms and busts.
Most U.S. cities have demonstrated fairly stable home price trends over time, notes the report, with only 20 percent of 361 cities experiencing either a boom or a bust. That"s due primarily to healthy or unhealthy local economic climates.
Prior to 1998, 46 cities experienced home price booms, with only 21 instances of home price busts. "In just 9 of 54 unique boom episodes prior to 1998, or roughly 17 percent of all such events, did a bust subsequently occur within a five-year window," says the report, suggesting that stagnation in home prices is a more likely outcome of booms than busts. "Of the 54 boom episodes prior to 1998, 45 did not see a subsequent bust."
Concluding that booms don"t necessarily lead to busts, the FDIC explores periods which did result in "distress" for homeowners, two case studies involving the "oil patch" states of the mid-1980s and the 1990s bi-coastal collapse. These two major regional episodes were associated with "rather severe, localized economic shocks that tended to affect major employers."
"When oil prices surged in the late 1970s, the oil-producing areas of Texas, Oklahoma, Louisiana, Colorado, Wyoming, and Alaska began experiencing an economic boom and population inflows. As the economies in these cities accelerated and their populations surged, demand for housing naturally boomed," explains the report, with cities such as Houston and San Antonio reporting double-digit home price appreciation.
"After surging 250 percent between 1978 and 1980, crude oil prices began a six-year decline that culminated with a 46 percent price drop in 1986," says the report, resulting in gains unraveling beginning in 1983 with job loss and population outflows. "In the worst cases, nominal home prices fell by 40 percent and 33 percent in Lafayette, Louisiana, and Casper, Wyoming, respectively, between 1983 and 1988."
"One of the worst years of population loss for these cities was 1987, when Anchorage lost 2 percent of its residents, Odessa-Midland"s population dropped 5.4 percent, and Casper saw a net outflow of nearly 7 percent of its residents," remarks the report that "population outflows are extremely harmful to housing markets, because they both depress demand for homes and raise the number of homes on the market."
The busts in California and the Northeast also had "common elements of economic stress, including the early 1990s recession, massive defense downsizing after the end of the Cold War, a significant commercial real estate collapse, and either a sharp downturn in population growth or outright population loss."
"Based on our sense of economic history, it seems that while significant economic distress may be a necessary condition for sizeable home price declines to occur, a prior home price boom may not be," reasons the report. "However, it is likely that the longer and higher home prices rise, the more they may become out of line with economic fundamentals, which could make them more vulnerable to economic shocks. Should a shock occur, it seems reasonable to expect that home prices would be more likely to decline, and perhaps even bust, in those markets where prices have recently boomed."
Sensitive to economic shocks and population loss, any market can succumb to a bust, even though a preceding boom is not the strongest factor in the decline. However, says the report, booms don"t last forever.
"Between 1978 and 2003, the nationwide home price index (HPI) grew an average of 5 percent per year in nominal terms. Even after allowing for strong local population or economic growth that could temporarily boost home price appreciation, the 20 to 25 percent price gains that have been witnessed in some cities in recent years clearly are not sustainable over the long term," warns the report. "Second, we have seen that most booms usually do not go bust but instead tend to result in a period of price stagnation. Finally, busts do sometimes follow booms. In those instances, severe economic shocks -- often including a net outflow of population -- appear to be a key factor in pushing nominal home prices sharply lower. Home price declines do not occur simply because home prices have boomed, and they do not occur independently of local economic conditions."
So what does the report say about recent price gains? History is an imperfect guide due to changing factors, suggests the report, primarily changing credit that is "pushing homeowners and housing markets into uncharted territory."
"The run-up in real home prices since the late 1990s has been quite pronounced, spanning the nation"s largest cities and a good number of metro areas in California. Our count of 33 boom markets in 2003 is the highest witnessed at one time during the past 25 years -- 1988 ranks second, with 24 booms. Moreover, the 2003 boom markets account for roughly 40 percent of the nation"s population base, contributing to the impression that this is a nationwide phenomenon.
"A major financial development in the 1990s was the emergence and rapid growth of subprime mortgage lending," says the report, resulting in 10 percent of all mortgage debt, which raises the levels of delinquency and foreclosure.
In addition, "homebuyers are also increasingly availing themselves of higher-leverage mortgage products. In 2003, loans exceeding 80 percent of the home purchase price accounted for 30 percent of all purchase mortgages underwritten. In a few cities, this share exceeded 50 percent. More borrowers are taking on second mortgages at closing. One method of doing so involves "piggyback" loans, which combine a first mortgage, usually for 80 percent of the value of the home, with a "piggyback" second mortgage amounting to 10 to 15 percent or more of the value of the home. The effect of this structure is to raise the total loan amount to a level very near the value of the home, which may make borrowers more likely to default in the event of a housing market downturn."
Increased incidences of default and foreclosure could, in turn, "contribute to downward pressure on home prices as distressed properties are liquidated by lenders."