Over the past few years, home prices have gone up a lot, but it looks like the real estate world is about to catch up with us. The forecast for home prices in 2006 is mild and moderate. Prices are expected to go up, but not by as much as they did in 2005.
Also, the forecast for 2005 was mild and not too bad, but it turned out to be way too low.
The National Association of Realtors said that the prices of already-owned homes were expected to go up by 5.3% in 2005. Now, though, NAR says that the prices of already-built homes will go up by 12.7 percent in 2005. If the most recent estimate from the NAR is correct, it would be the biggest price increase in one year since 1979.
NAR says that the prices of already-owned homes should go up by 6.1% in 2006.
Based on what we know about home prices, a 6.1 percent increase per year doesn't seem like much. According to NAR data going back to 1968, cash prices have gone up an average of 6.4 percent per year. Also, it's important to remember that real estate is a local good, so what happens in one area may be very different from what happens in the rest of the country. It's not impossible for prices in one neighbourhood to go up while the national average goes down, or the other way around.
As a result of NAR's moderate prediction and the slowing down of price growth across the country, two things are clear: First, is there no more "bubble"? Second, what should smart buyers, owners, and lenders do next?
Let's start by saying that there hasn't been a "bubble," which is a word that means an unjustified rise in value. Instead, we've seen an unusual set of events that, taken together, have made real estate the best way to invest right now.
In the past few years, interest rates have been at all-time lows. From 2003 to 2005, you could get a loan or refinance for 6 percent or less for a lot of the time. When interest rates go down, more people can compete for homes, which drives up prices.
In many big cities, building a new home takes longer, is harder, and costs more because of strict zoning rules and a shrinking supply of buildable land close to the city. What happened? Prices are higher for the properties that are still for sale.
Between 2000 and December 2005, the number of people rose from 282.2 million to 297.9 million. This means that an extra 15.7 million people need a place to live. Again, when there is more demand, prices go up.
Real estate has been a good place to invest in most places, but not all. This is especially true when you look at the other options. On January 14, 2000, for example, the Dow Jones Industrial Average hit 11,722.98. On December 14, this year, nearly six years later, the average was more than 800 points lower, at 10,883.51. NAR says that the average price of an existing home went from $139,000 in 2000 to $218,000 in October 2005.
Part of the reason why home prices have gone up is that houses have gotten bigger. In 1987, the average house was 1,755 square feet, according to the National Association of Home Builders. By 2004, the average house was about 2,140 square feet. Cost per unit goes up as size goes up.
Some of the things that have made prices go up in the past few years are starting to slow down.
Interest rates for 30-year loans are now above 6.3%. This has been a great rate for most of the last 50 years, but it is 1% higher than the fixed-rate mortgage levels seen in 2003.
Two things happen when interest rates go up: First, they put limits on how much more borrowers can bid. Second, they limit how many people can bid at each price point. A 30-year fixed-rate loan for $200,000 at a rate of 5.3% costs $1,110.61 per month in principal and interest. With the same monthly payment and an interest rate of 6.3%, the borrower can only get $179,428.
Rates have gone up in 2005, and there is reason to think they will go up even more.
The recent hike in energy prices, as one example, is nothing more than a universal tax on every transaction, product and service. It raises costs that people, governments, and businesses will try to get back by raising prices, taxes, wages, and interest rates. Higher energy prices also make it more expensive to own a home.
What's it all about? Look for a gradual shift toward smaller, less expensive homes that use less energy and cost less to buy and run. With less appreciation, you can expect less speculation, which will lead to even less demand. Lastly, you can expect smart borrowers to keep costs down in the future by refinancing now with fixed-rate mortgages, before rates go up even more.
