....downturn would only last a couple years

By JEANNE MORRIS
Sunday News Staff
July 3, 2005

New Hampshire's red-hot real estate market is expected to enter a painful price-correction period starting in late 2006 that economists say will result in a 5 percent to 25 percent drop in home prices.

Economists have long talked about the bursting of the housing bubble, but until recently few agreed on its timing. Now, there appears to be a growing consensus among state and national economists that the price-correction will hit late next year, and be in full swing by the end of 2007.

Once begun, experts said a soft housing market is likely to last about five years.

Many economists believe house prices will continue to rise until then. But, New Hampshire economist Russell Thibeault of Applied Economic Research in Laconia said most recent home sales figures for New Hampshire over the past five months indicate prices have stopped increasing. Prices have leveled off, he said.

"The rapid house appreciation is on its last legs, and when interest rates go up prices are going to go south," Thibeault said.

There is, however, strong disagreement concerning the severity of the price correction. Some say house prices will fall only 5 percent while others believe a drop of 40 percent or more is coming to select parts of New Hampshire that were swept up in the buying mania that Federal Reserve chief Alan Greenspan characterizes as "frothy."

Rent/price multiples

Economist Denis Delay, a director of special projects with New Hampshire Workforce Opportunity Council, used the traditional economic model that measures the disparity between the price of renting a home versus buying it to determine the magnitude of the coming correction.

Economists look at rent/price multiples much as they do price/earnings ratios for stocks to assess the intrinsic value of the house. Rents generally rise at the same rate as home prices, but recently, home prices have soared well above rents to all-time highs.

Comparing those numbers, Delay said, "There is going to be a 20 percent price correction. This correction could come in a leveling off, or decline."

Varies by area

Some areas of the state, such as the Lakes Region, will suffer a significantly larger drop than other areas, Delay said.
Laconia is likely to undergo a 25-percent drop in home prices because this area has seen a much higher than state average run-up in prices due to investors pouring speculative money into the housing.

Other areas of the state — such as Berlin, which has seen a slower than average price rise — will be least effected. In Berlin, for example, Delay sees a price correction on the order of 5 percent or less.

"There's some interesting differences as you go across the state," Delay said. "Some parts of the state, such as Manchester, the ratio of rents to (home) prices is up but probably around the national average. And then in some places like Laconia, the ratio of rents to prices is so ridiculous it looks more like Long Island or California."

Also, he noted, the underpinnings of the Lakes Region housing prices differ from much in the state in that they are not tied to the state's economy.

"In the Lakes Region, the rapid increase in home selling prices has nothing to do with what's going on in the local economy. You've got a lot of very rich people buying, which can be OK, functional, as a marketplace as long as rich people keep buying homes," Delay said.

Using the rent versus ownership price index, Delay calculated that Manchester's correction will be 10 percent, Nashua 20 percent, Portsmouth 15 percent, Concord 15 percent, Salem 20 percent, Keene less than 10 percent, Littleton 10 percent, Conway 20 percent, Claremont 20 percent, Plymouth 15 percent, Peterborough 20 percent, Lebanon 10 percent or less and Berlin 5 percent or less.

Nationally, the after-tax cost of owning exceeds the cost of renting a comparable home by 28 percent nationally, and by much more in certain areas of the country, according the 2005 report by Harvard University's Joint Center for Housing Studies. In 2003, the study found the cost was 23 percent more to own than rent a comparable home.

Watching interest rates

High Tech Strategist editor Fred Hickey of Nashua, who gained national notoriety for predicting the high tech recession, thinks Delay's numbers are far too conservative.

Hickey said a 20 percent correction would only bring prices back to what they were a year and half ago. And even at that time, house prices were over inflated, he said.

Thibeault, on the other hand, thinks the correction will not be more than 20 percent and probably less. He said the decline will start some time in 2006, when he sees interest rates climbing above 6.5 percent. Low interest rates have fueled the housing boom the past 13 years.

"The drop will depend upon how high that (rates) go," he said.

He said if rates go up to 8 percent, "the average New Hampshire household can afford to pay 15 percent less for a house."

"I think there's a better than 50/50 chance prices will go down," he said.

Other market factors

Economist Celia Chen of Economics.com researches the greater Boston area and New England housing market: "There's definitely going to be an adjustment."

Based on the great disparity between house price growth and income growth, Chen expects prices to dip as much as 5 percent starting in the middle of 2007.

"Yes, we'll have some price decline. But, we don't see a huge decline in prices, at least not the same decline that occurred in the 1980s," she said.

However, the decline could be great if there's a large slip in employment or economic growth, she said. Also, a bigger drop could happen if real estate investors sell their holdings in a panic.

"New Hampshire is going to follow Massachusetts and the Boston area, but it (price declines) will probably not be as severe as in Boston. For the state I would expect a slight decline in 2006 and 2007 in the order of a 1 percent drop each year," she said.

Chen expects there will be flat house prices for a few years as income growth closes the gap between home prices back to historic norms. "Income has not kept up with prices and that gap has been getting wider and wider," she said.

And that gap is particularly large in New England.

Home price run-up

According to an article by the Center for Economic and Policy Research, "The New England region has been at the center of this run-up in home prices, experiencing an increase in home sale prices that exceeded the overall rate of inflation by more than 70 percentage points over this period. The run-up in home prices in New England over this period was more rapid than in any other region of the nation."

After being adjusted for inflation, the center found that the increase in home prices from 1995 to 2003 in the United States was 34.7 percent. New England, however, jumped 59.6 percent, while the Pacific states rose 49.4 percent.

Regionally during 1995 to 2003, New Hampshire home prices were the second fastest growing for New England. Connecticut home prices jumped 36.4 percent, Maine 44.9 percent, Massachusetts 73.5 percent, and New Hampshire, 67.8 percent, according to figures from the U.S. Office of Federal Housing Enterprise Oversight and Bureau of Labor Statistics.

Riding it out

Once the market starts its downturn, all expect it will take a few years to turn around.
Chen said, "It's a cyclical market. The last downturn took a good three years to play out."

She said it generally takes about two years for prices to fall from their peak to their lowest point, and then another three to four years to work its way back to positive gains.

"There's a lot of excitement going on around the housing market, and people are predicting the collapse, but that will take a few years," Chen said.

Thibeault said there is a lot of talk about the housing bubble as more people have come to accept it exists. Two weeks ago, for example, Google.com found 365,000 hits for a search on "housing bubble." Last week it turned up over 1 million hits.

"It's a really hot topic," he said.

Forced to sell?

Thibeault said when the bubble does burst and prices fall, those who stand to be hurt most are those who haven't owned their property long and have been forced to sell.

"If you don't have to sell, you haven't realized a loss. If you can hang on, prices typically go back up," he said.

People selling because of a divorce, job loss or transfer are likely to get burned.

In the late 1980s and early 1990s, many homeowners in New Hampshire, saw their home prices fall far below the amount they owed the bank on their mortgages. At the time, the media published stories about people turning the keys to their homes over to the bank and walking away because the house was worth so much less than the bank note.

Thibeault said people caught in the downturn sometimes have to sit tight for many years.

"During the early 1990s at one point we had a three-year supply of housing on the market. It can take a long time to get out of that kind of rotten deal," he said.