Kelley School of Business, Indiana University, Bloomington
Because interest rates have remained at unexpectedly low levels during 2004, it appears that housing starts for 2004 will be slightly higher than we forecasted last year. Rates are expected to rise slightly during 2005 as the economic recovery continues, but there should also be continued job recovery. The thirty-year fixed-rate mortgage should gradually rise to 6.4 percent in the fourth quarter. The average rate for all of 2004 is expected to be 6.1 percent, only modestly above 2003’s 5.8 percent.
While rising interest rates tend to dampen the demand for housing, job growth increases the demand. On balance, we expect housing starts to fall slightly for 2005 to a level of 1.85 million units, down from the 1.93 million units expected for 2004. This is still quite strong by historical standards. The single-family component of housing starts is likely to set a record during 2004. Multi-family is not quite as strong because more families can afford to own rather than rent.
Existing home sales have been strong during 2004, after setting a record of 6.1 million in 2003, and should also remain strong during 2005. The National Association of Realtors (NAR) forecasts existing-home sales to rise 5.7 percent in 2004 to 6.45 million. New-home sales should also hit a record, increasing 10.8 percent to 1.20 million in 2004.
Expenditures for home additions and alterations are expected to be strong because homeowners’ equity has increased with rising home prices. High oil prices could produce a further rise in prices for certain building materials.
Low interest rates and the strong housing market during the past year put upward pressure on home prices. The median existing-home price will continue to show above normal appreciation, rising 7.3 percent in 2004 to $182,400. The median new-home price should increase 8.3 percent this year to $211,100. The rising cost of building materials has been partly responsible for upward pressure on home prices.
The low mortgage rate environment has also led to a strong demand for condominiums (condos) by people who might otherwise rent because they could not afford a home mortgage—especially first-time homeowners. In many areas of the country, condo converters have been buying apartments at unprecedented prices and converting them into condominiums.
Primarily due to low mortgage interest rates, housing has been relatively affordable, with the NAR Housing Affordability Index at 127. This means a family at the median income level is earning 27 percent more than needed to qualify for the median-priced home.
Interest in commercial real estate by investors has also been unusually strong during 2004 and is expected to continue during 2005. Investors who have been disappointed with the performance of the stock market and have a renewed appreciation for the importance of diversification are looking to commercial real estate as a way to balance their portfolios. This can be done in a number of ways, including direct real estate investments or purchasing shares of publicly traded real estate companies, such as real estate investment trusts (REITs). The share price of REITs like Simon Property Group, which owns malls, and Duke Realty, which owns office and industrial properties, has risen significantly over the past year.
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