Understanding Housing Prices

I recently read a real estate research paper that analyzed factors that contributed to house price fluctuation. Give the slaughter that is occuring in other markets, its no wonder that this is a subject of interest. The paper concluded that overbuilding and employment were the biggest factors that consistently predicted price changes in homes.

Lets review the family of fundamental variables that determine prices and see how our market stands up:

1. Employment Growth - Jobs drive the economy. If you have a job, you can pay for your own place to live. If you have a job and don't want to live in your parent's basement your whole life, that is exactly what you do. You leave. This drives up demand for housing which affects price.

2. Population Growth - This is another supply and demand issue. More people moving into one given space pushes up demand for housing and therefore price. You would hope that that everyone that moves in does so with a job. Nevertheless, you don't necessarily need job growth during a period of population growth to push up prices. EXAMPLE: Iraqi refugees left in droves during the early days of the Iraq war. They went to Damascus, Syria. Rents (and it's corollary prices) in Damascus increased by over two fold for a time due to the huge population pressure. Home building is the natural result of population growth. Overbuilding occurs when builders overestimate population growth.

3. Income Growth - People bid for homes based on what they can afford. The more they earn and therefore can afford as a group, the more they will pay for a given home as they compete with each other for the desired home.

4. Construction Costs - If a home costs "X" dollars to build, the contractor will charge you "X+some profit" to build the home. If he just charges you "X" then he has no incentive to build. At some point, building will stop if "X" gets too high, but construction costs cannot be ignored in pushing home prices up.

5. Real Interest Rates - This is a little complicated. Lets just say that people factor in inflation and given mortgage interest rates when making purchase decisions and these have an affect, albeit minimal, on prices. If rates are high right now, it may signal upward increases in price later as lower interest rates translate into lower payments which means people can afford to pay more for a house and keep their payments the same. Inversely, if rates are low now, it may signal a decrease in price later as the opposite happens. Regardless, this factor happens to have a very small impact on pricing because people typically make purchases as a hedge against inflation. In essence, inflation and interest rate moves cancel each other out over the long run.

OBSERVATIONS IN OUR MARKETPLACE

1. Employment Growth - Utah just got over a binge of job growth. We are now going to let go of some of those jobs as unemployment likely reaches 5.5% for the state. That will be the highest it has been in 25 years or more. That WILL have an impact on pricing. Salt Lake will be affected more than Weber County or north Davis County. How this manifests itself in the pricing arena is in bank owned or wholesale pricing. When people lose their jobs and stop paying mortgages they give their homes back to the bank. The bank doesn't want the home so it discounts it at sale to get rid of it. This gets factored into the average price you hear reported. Keep in mind that despite this coming softening in overall prices, we will continue our general plateau that is consistent with the Utah cycle .

2. Population Growth - Utah just got over a huge growth spurt in population. Like The Hotel California, Utah has this weird quality of people moving in but really never leaving. Part of it is the family-centered culture (ask my wife what happened when I tried to move her out of state). Another aspect is the overall quietness of the culture combined with an excellent climate and great outdoor recreation. The point is that the population here is not and likely will not decrease. It will increase even if we are losing jobs. (We should also consider that a jobless man spending TOO much time at home with the Mrs. will spur population growth...if you get my drift.) This is probably the stabilizing factor that keeps our prices from softening very much when they do soften.

3. Income Growth - This will likely soften as jobs are lost and some folks are put on part time rather than full time. I see this being a mild force affecting prices.

4. Construction Costs - For people wanting to build a home, they can do so very cheaply right now. Construction materials have declined considerably. Also, all the under-employed construction workers are competing for scarce jobs and are working much less than they were 18 months ago. If you can qualify for the financing, you can build a larger home than you could afford last year.

5. Real Interest Rates - Rates are as low as they will be for the next 40 years in my opinion. This makes homes, for those who qualify, the most affordable they have been or will be for some time.

THE BOTTOM LINE

If you know where you are in the real estate cycle, you can plan accordingly and end up where you want to be. Now is always a good time to buy real estate, the key is DOING IT IN THE RIGHT WAY. The right way depends on your goals and where you are in the real estate cycle. The reassuring thing is that if you buy the right way with your goals in mind, you will always come out ahead. Let me show you how it's done.