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Home Price Analysis for Denver-Aurora
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By the Research Division of the National Association of REALTORSฎ
Executive Summary
With home prices rising strongly in most parts of the country, there has been widespread media coverage on the possibility of a housing market bust. A thorough analysis of the Denver-Aurora metro market, as detailed below, reveals that there is very little danger of this. In fact, the local housing market is in excellent shape with a potential for significant housing equity gains, particularly for home buyers who plan to remain in their house for
the long run.
Because prices have risen faster than income, the ratio of price-to-income has been rising. This measure is frequently cited to imply that there is a housing market bubble. But this ratio is a misleading measure in assessing bubble prospects. A more relevant measure is the mortgage servicing cost relative to income. This ratio is only minimally higher than the local historical average. It implies no widespread financial over stretching to purchase
a home in the region.
Price Activity
The current price of $248,400 is 20% above the national average.
The median home price rose 3.8% in 2004 and 9% in the past three years -
one of slower appreciating areas in the country.
Home prices had been relatively flat in the 1980s. So part of the strong
increases in the 1990s can be attributable to the catch-up effect.
Affordability
Because the prices have risen faster than income, particularly during the
late 1990s, the ratio of price-to-income is currently above the historical
norm. This measure is frequently cited to imply that there is a housing
market bubble.
Mortgage rates declining to 45-year lows have been a major force in
boosting home prices in recent years. Lower rates allow home buyers obtain
a larger loan without necessarily increasing monthly mortgage payments.
A more relevant measure for assessing the risk of a home price bubble is
the median mortgage servicing cost relative to the median income. This
ratio is well below the local historical average. It implies no widespread
financial over stretching to purchase a home in the region and a capacity for
a strong increase if the recent job gains were to continue.
Local Fundamentals
Jobs took a hit in the recent recession. But, the situation is improving as
21,100 jobs were added in the past 12 months to July. Many new job
holders seek their own housing units.
The region added an estimated 125,000 new housing units of which 90,000
were single-family units in the past five years.
The ratio of five-year job gains to five-year new home construction shows
the hangover impact of the housing shortage, or housing surplus. In our
case, the local market is oversupplied as the ratio is below one. But this
ratio is largely a reflection of the job losses that occurred in 2001 to 2003.
The ratio will strengthen once job are created on a consistent basis.
Other Factors
Interest-only loans accounted for 43% of all loans, while ARMS accounted
for 59% in 2004 in the local region. The figures are likely to be modestly
higher in 2005. Therefore, some homeowners could feel the pinch of
higher rates over time.
But due to the fact that only 8% of the loans have loan-to-value ratios
above 90%, the foreclosure risk is minimal. (That is, prices would have to
decline by more than 10% to have a measurable impact on foreclosure
rates.)
The baby boomers in their peak earning years and have been active in
purchasing second homes, which many consider their future retirement
homes. The baby boomer impact could continue for another decade.
The local market will benefit from second-home purchases by U.S. baby
boomers being near mountains and from being in a city with many cultural
amenities.
Stress Test
Price declines in the local market are unlikely according to our stress test.
The local housing market will experience a price decline of 5% only under
extreme unlikely scenarios. For example, mortgage rates rising to 12.3% in
combination with local job losses totaling 36,000 could lead to a price
decline. If rates rise above 13%, then if job creation may not support home
prices.
Various scenarios that could lead to a price decline of 5% are shown below.
Such scenarios are highly unlikely. Most credible forecasts predict the
region will create at least 40,000 jobs over the next 24 months and
mortgage rates will hover around 7% by the end of 2006, which bodes well
for future price gains.
Even in the unlikely event of prices declining by 5%, most homeowners will
maintain sizable equity build-up in their homes. The table below shows
the home equity gains if prices were to fall by 5% by home buyers at various
years of purchase.
Housing equity will most likely continue to accumulate to local
homeowners. The equity gains under three price growth scenarios are
presented below. One scenario assumes a historical conservative price
appreciation of 1.5% above consumer price index inflation. With most
credible inflation forecasts pegged at 2.5%, home prices can expect to rise
by 4% per year under normal circumstances. The two other scenarios
assume slightly below (1.5%) and slightly above (6.5%) the normal rate of
appreciation.
The local market is more likely to appreciate at an above-normal rate
because of the resurgence in the technology industry and the
accompanying strong job growth. The region is also very affordable in
relation to California markets, where many new residents are arriving from.
Additional Discussion Points
Home price declines are very rare. In fact, the national median home price
has not declined since the Great Depression of the 1930s. Stock market
collapses, the OPEC oil crunch, economic recessions, and even wars have
not negatively impacted national home prices since the 1930s.
There have been few times when local prices declined. In nearly all these
cases, the price declines were accompanied by sharp prolonged job losses.
It is difficult to foresee a price decline in a job creating economy.
Homes trade far less frequently than financial assets (about one home sale
every 7 to 10 years for most homeowners). There are also larger
transaction costs associated with selling a home due to the lengthy careful
examination demanded by home buyers and sellers. Therefore, home
prices are not prone to fluctuations as in the stock market. There are
neither panic sells nor margin calls associated with homes.
Many non-quantifiable factors could be important for this metro market in
determining home prices. Access to cultural life, the quality of museums,
nearby local and national parks, water views, exclusive neighborhoods,
weather, the international airport, city vibrancy, restaurants, and a host of
other non-quantifiable factors could have an important influence on the
overall pricing.
There are immense tax benefits to owning a home. These tax
considerations were not considered in the analysis. For example, the 1998
law permitting primary owner occupants to trade down without having tax
consequences. Also most home sales results in no capital gains tax. In
addition, long-term capital gains tax rates were reduced in 2003, thereby
providing higher return for home investors. These positive benefits, if
accounted for in the analysis, would have shown an even stronger case for
housing fundamentals in supporting home prices.
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