In recent weeks, you've likely watched and wondered with bewilderment as the stock market continued dipping and swooning while prices for new homes and resales continued upward at a somewhat unrealistic pace. How, you might be asking, is it possible that housing prices continue to escalate while the economy is, at best, sliding sideways?
Some experts predict that housing prices are approaching their peak just before the inevitable downfall. Others, however, argue that the market forces at work effecting the stock market are entirely different from those effecting home real estate. They view the current escalation of prices as nothing more than an accurate reflection of the increase in household income, which increases in tandem with home prices.
In other words, prices aren't off the charts at all but merely a reflection of household income.
The disconnection evident between the overall economic slowdown and the rise in housing prices indicates that income has kept pace with pricing. According to David Wyss, an economist with Standard and Poor's, prices of both new and resale homes relative to household disposable incomes are lower today than they were in the 1980s and 1990s. Go back 20 years, he says, and the price of a new home was 3.1 times the average household's annual disposable income, compared to today's average of 2.6.
The cause of this income growth can be directly attributed to the increase in two-income households, which now constitute the bulk of the housing market and can afford considerably more than their forefathers. Add in the low cost of mortgage money, and purchasers can afford a lot more home today than they could in recent decades.
The monthly principal and interest costs associated with the median-priced resale homes today represent 16 percent of household income. In the early 1990s, by contrast, that figure was 20 percent; in 1988, it was 23 percent.
Financing creates value. Low-cost financing allows consumers to afford higher pricing in tandem with higher prices. It wasn't that long ago, 1990 to be exact, that the average annual rate for a new 30-year fixed rate loan was 10 percent. In 1981, the average annual rate was 16.6 percent.
The decrease in the amount of money brought to the table in the form of a downpayment has allowed values to be dramatically affected. With money being cheaper to borrow and less of your own needed at closing, the result is you can afford more house at a higher price.
In addition, lower interest rates have allowed homeowners to add $100 billion in value by remodeling and upgrading what they own -- adding media rooms, luxury kitchens and health spas disguised as bathrooms. The logic here is simple: Homes today are larger, with more amenities, than they where just five years ago and are worth more and therefore sell for more.
Another component of this rise can be traced to the federal government's reform of tax policy. With the elimination of the tax on most home sale profits and changes in capital gains taxation, the groundwork was laid for today's higher prices.
Where else would it be possible to overpay for a capital asset, keep it for a few years, sell it and put up to $500,000 dollars in your pocket tax free? Only in America.
This Week's Tip: Legal Addition
While it's hard to get away with building an addition in the city without all the requisite permits, it's not uncommon for folks to build something only to find out later that it wasn't OK. If you're doing it yourself, be sure to check with all concerned local officials that all the permit requirements have been met.
Work with the inspectors, as they're your friends. If you're contracting the work, make sure the contractor isn't taking shortcuts and side-stepping the regs. There are tons of rules about what can and can't be done and where you can and can't do it.
If you proceed with an addition, remember you don't get to visit the site and then go home as if building a new house. You'll be living in a construction zone for a period of time that will seem endless, and you'll have a new understanding of the word "stress" before it's over.
STEVEN J. LOWENSTEIN, a native of Cincinnati, is a Realtor with Coletta & Associates Realtors. He's a graduate of the University of Cincinnati and holds a Master's degree from North Texas State University.
