Housing Boom Or Bubble?

Homes are going up at a record pace

If you need proof that the business cycle is different this time around, take a look at today's housing sector. While residential housing usually takes off like gangbusters in the early stages of a recovery and loses steam as an expansion ages, it is actually booming--eight years into the current cycle.

Last year's statistics tell the story. New and existing home sales shattered all records. Median existing-home prices rose 5% for the third year in a row. Counting manufactured housing, some 2 million homes were built--the most since 1978, when baby boomers were starting to form households. And the share of households owning their own homes has hit a record 66.6%.

The housing boom's impact on the economy has been pervasive. Economist Mark Zandi of RFA, an economics consulting firm, estimates that housing--directly via construction and indirectly via stimulus to sales of furnishings and other items--accounted for a quarter of the economy's near 4% growth last year.

The big questions, though, are how long the boom can last and whether it will end in a sharp contraction. Zandi warns that housing construction now outpaces underlying demographic demand--pegged at 1.7 million homes a year over the next decade to meet the needs of population growth and scrapped units.

Economist David W. Berson of Fannie Mae thinks several long-term trends should help to limit future falloffs in housing activity. One is the use of new credit criteria by mortgage lenders to reach low-income home buyers who are good credit risks but were turned away in the past. Another is the huge surge in legal immigration in recent decades. Although home ownership among immigrants is initially low, it rises rapidly after a decade or so.

The aging of the baby boomers is also boosting housing demand--not only because homeownership rises with age (chart), but because the leading edge of the baby boom is entering its 50s--a period when demand for second homes rises sharply. Economists at Standard & Poor's DRI expect such demand to grow steadily for the next 20 years.

Meanwhile, RFA's Zandi concedes that the near-term underpinnings of the housing market remain solid. Inventories of new and existing homes are at or close to record lows. Unemployment is low, and income growth is strong. The stock market is still buoyant, and mortgage rates remain below 7%--the lowest they've been in a generation.

Thus, while he expects housing demand to weaken later this year as the economy slows, Zandi sees little sign that this is about to happen. A risk, he says, is that overconfident homebuilders will be slow to react when demand finally falters--prolonging the housing boom by putting up more houses, but eventually turning what might have been a slowdown into a sharp decline.

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