real estate

Housing Outlook, 2015

Prices in most cities are heading higher, but the eye-popping gains have mostly disappeared.

Like a long-distance runner trying to find his stride, the housing market is slowing its pace as it gains back the equity lost in the meltdown of 2006 to 2007. Over the past year, home prices rose in 246 of the 277 cities tracked by Clear Capital, a provider of real estate data and analysis. But in two-thirds of the cities with price increases, the gains were lower than they were the year before. The slowdown reflects a softer market as investors throttled back and first-time buyers encountered credit headwinds.

Use Our Tool: See Home Prices for the 100 Largest Metro Areas

In the years leading up to 2014, some of the regions and cities hit hardest by the housing bust experienced huge gains—essentially an overcorrection to the correction. In 2014, among cities that experienced double-digit price growth, Detroit topped the list with a gain of 20.9%, followed by most of California (including San Jose and San Francisco, the nation’s most expensive housing markets), Atlanta, Miami and Las Vegas. Yet prices in many cities are still significantly lower than they were at the market’s peak in mid 2006. And across the U.S., home prices are still 23% lower, on average, than they were in 2006. During the correction, home prices fell so far that most metro areas were undervalued compared with what they would have been if they had just plugged along without a boom or bust.

That doesn’t necessarily mean that they are undervalued now, says Andres Carbacho-Burgos, a senior economist with Moody’s Analytics who covers housing. Most metro areas are about where they should be, he says. Kiplinger forecasts that home prices nationally will rise by 3.5% in 2015, at the low end of the historical range of 3% to 5% annual appreciation (before inflation). We also expect existing-home sales to increase 8% in 2015 (after declining 2% in 2014) and new-home sales to rise 25% in 2015 (after a meager 4% rise in 2014).

First-time buyers step up

For the past few years, investors were lured by an abundance of bargains and high demand for rental properties. As prices rose beyond the point where investors could get their desired return, demand began to wane.

Now the housing market has begun to transition from one phase of recovery to the next. Buyers who actually live in their homes must pick up where investors left off for there to be real growth, says Alex Villacorta, chief data analyst for Clear Capital. Homeowners who trade up don’t provide that growth because they usually swap one home for another. That leaves first-time buyers—including the record number of 25- to 34-year-old boomerangers who have been living with their parents or grandparents—to propel growth.

Jeff and Emily Bain, both age 30, of Austin, Texas, recently took the leap to homeownership. Emily began house shopping online six years ago, watching as rents and home prices rose in Austin. At the beginning of 2014, the couple decided to stop “jawing” about it, says Emily. By June, they had finished saving $30,000 for a down payment and safety net and set out to find a $200,000 home.

After visiting about a dozen homes with their agent, Kimberly Tortorice, of Keller Williams, the couple were surprised to find exactly what they wanted in a house, right down to its red front door. They paid $185,000 for their three-bedroom, two-bath ranch-style house. They had enough for a 10% down payment and stable jobs, great credit and relatively little debt (Jeff owes $11,000 in student loans), so they easily qualified for financing. The Bains took out a 30-year fixed-rate mortgage with a rate of 3.875% and closed on the house in mid September. The couple’s mortgage payment of $1,150, which includes private mortgage insurance, is less than their previous rent of $1,200 a month.

Many young people who would normally fill the ranks of first-time home buyers were set back by the sluggish economic recovery. Incomes stalled, depriving them of the means to get a handle on outstanding debt, including student-loan debt, which has tripled in the past decade. Households with student debt have a tougher time meeting tight credit standards, especially strict down-payment and debt-to-income-ratio requirements. Plus, a rise in student-loan delinquency has pushed down many credit scores, says a report by TD Bank.

Crushing student-loan debt is a big reason that Chris and Sarah Berg of Laurel, Md., have resigned themselves to a longer timeline for buying a home. Although the couple both have good jobs, Chris, 36, carries $100,000 in student loans from graduate school (he’s repaying them over 25 years). Sarah, 38, is rebuilding her credit score, which took a hit when Chris was still in school and they started their family—Arabella, 8, and Johann James, 4. It doesn’t help that new townhomes in Laurel, which is located halfway between Baltimore and Washington, D.C., go for about $400,000.

See Also: Mortgage Rates Where You Live

The Bergs needed more space for their family when their apartment lease ended last July, so they rented a three-bedroom, 2.5-bath townhome with a back porch and yard for about $1,800 a month. Their credit union tells them it will be a couple of years before they can buy as they save for a down payment, pay down debt and improve their credit scores. Home prices and interest rates may be higher by then, but the Bergs are resigned to waiting. “We’re still saving for a down payment, but a little slower,” says Sarah.

The NAR's annual "Profile of Home Buyers and Sellers" shows that the share of home purchases by first-time buyers is at its lowest level since 1987. Since 1981, first-time buyers have been responsible for 40% of all home purchases, on average. But their share fell to 33% in 2014. What will get more first-time buyers to the settlement table? “It’s all about consistent job growth for a prolonged period, and we’re entering that stage,” says Lawrence Yun, chief economist of the National Association of Realtors. Continued low interest rates and the expected loosening of credit standards will also help.

Builders pick up the pace

In the past year, the supply of existing homes nationally has been mostly balanced between buyers and sellers, at about five months’ supply (the time it would take to sell the current inventory at the current pace of sales). But supply in some cities has been superlow, strongly favoring sellers. Seattle recently had just 1.6 months’ supply, reflecting strong demand from Chinese investors who have been priced out of Vancouver and San Francisco. It’s also a seller’s market in San Jose (in Silicon Valley), Austin, Houston and Boston. With few homes to choose from, buyers face bidding wars and take-it-or-leave-it sellers.

Many owners of existing homes have been holding out for higher prices. But even if they list their home for sale, the impact on supply will likely be a wash because most of them want to trade up or downsize, says Yun, of the NAR. The key to more choices for buyers is new inventory, and it’s coming, albeit slowly.

In 2014, construction of rental apartments and condos returned to pre-boom-and-bust levels. But construction of single-family homes made it just halfway back to the normal annual average of 1.3 million starts, says Robert Denk, an economist with the National Association of Home Builders. The NAHB forecasts that single-family-home starts won’t hit the million mark until 2016. Material shortages and price spikes have eased, but skilled labor and buildable land are scarce. The biggest hurdle continues to be access to credit, both for the builders and their buyers.

Still swimming against the current

The number of U.S. homes somewhere in the foreclosure process fell in September to the lowest level since before the bust. But a lot of homeowners are still underwater, meaning that they owe more on their mortgage than their home is worth and can’t put their houses up for sale without losing money. In the third quarter, 15% (5.4 million) of all homes with a mortgage were underwater by at least 25%, down from one-fourth of all homes a year ago, according to RealtyTrac, which publishes data about distressed properties.

The options for underwater homeowners aren’t pretty. They may be able to refinance through the Home Affordable Refinance Program and hang on to their house. They could do a short sale, but they may face a tax bill on the forgiven debt (unless Congress retroactively extends protective legislation that expired in 2013, which Kiplinger thinks it will). Or they could bail out via foreclosure.

The states with the most underwater homeowners at the end of September were Nevada (almost one-third) and Florida, Illinois, Michigan and Rhode Island (about one-fourth). Says Daren Blomquist, vice-president of RealtyTrac, “The decrease in underwater properties is promising, but the floodwaters aren’t receding as quickly as they were before.”

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