Mass. Home Prices Expected to Drop

Personal income not keeping pace



WESTBOROUGH -- The gap between income and Massachusetts home prices is the widest since the peak of the 1980s housing bubble, and that gap, intensified by rising interest rates, should cause home prices to dip later this year, according to an economic forecast released yesterday.



The forecast, by the New England Economic Partnership, projects a modest housing slump in Massachusetts that will last through early 2007, with prices, at the bottom, declining about 3 percent. The slump would be far milder than the housing bust of the late '80s and early 1990s, when prices fell 11 percent and took nine years to recover, according to the partnership, a nonprofit forecasting group. ''It's not going anything like the '80s, but there's going to be a correction," said Alan Clayton-Matthews, the University of Massachusetts at Boston professor who prepared the forecast. ''There has to."



The main reason: Income is not keeping up with home prices, which have advanced at double-digit annual rates in recent years, Clayton-Matthews said. The state's median home price last year was 6.8 times higher than per capita income, the biggest spread since 1989, when the median price was 7.6 times higher than income. Nationally, the median home price last year was 5 times higher.



A widening price-to-income gap means that even modest increases in mortgage rates would cut potential buyers out of the market, reducing demand and possibly leading to falling prices. Economists at the New England Economic Partnership conference, where the forecasts were released, said they expect rates to rise modestly over the next year, but added that an '80's-style real estate collapse is unlikely.



Unlike the end of the 1980s, when the region was slipping into recession, this time the Massachusetts and New England economies are strengthening, they said. In addition, banks are in far better shape today. In the late '80s and early '90s, many banks were unable to weather the mortgage defaults, leading to failures and fire sales of foreclosed properties, which further depressed prices.



So far, the current housing boom has shown few signs of cooling. With mortgage rates remaining below 6 percent, a historically low level, sales and prices have continued to soar.



In Massachusetts, for example, home sales in the first three months of the year rose nearly 14 percent compared to the same period a year earlier, according to the Massachusetts Association of Realtors. The state's median single family home price rose 11.9 percent to about $346,000 while the median condominium price rose 14.5 percent to about $265,000.



John Dulczewski, spokesman for the association, said the group expects home sales to slow and prices to moderate this year, but not to fall. Even though mortgage rates are likely to rise, an improving economy and job market should continue to spark demand.



He added that supply remains tight. Last year, the state had only a 6.6-month supply of homes, compared to 8 months in a so-called balanced market when supply and demand are about equal. In 1996, shortly before the housing market began its recovery, the state had a 9.4-month supply.



''We are still calling for price appreciation," Dulczewski said. ''The supply just hasn't kept up with demand."



Massachusetts' high home prices, nearly double the national median, are a growing concern for economists and policy makers, who worry they are driving young workers and families from the state. Over the long term, economists said, the aging New England population and the loss of younger workers would result in labor shortages and slower growth.



''It's not a pretty picture," said Ross Gittell, a professor at the University of New Hampshire.



Economists said yesterday that the longer prices soar, the more severe the correction is likely to be. Mark Zandi, chief economist of www.Economy.com, said the housing market, fueled by low interest rates, is becoming increasingly speculative in many metropolitan markets, including Boston. This means buyers, instead of basing decisions on fundamentals, are betting that prices will rise, leading them to stretch their finances and take out risky, short-term mortgages that are vulnerable to interest-rate increases.



In California, for example, two-thirds of mortgages in the first three months of the year were interest-only adjustable rate mortgages. Buyers pay only interest for the first few years of the mortgage, after which rates are adjusted and principal payments begin. These mortgages mean lower initial payments, but should interest rates jump, it could make the mortgages unaffordable for some, leading to defaults, foreclosure sales, and falling prices.



Zandi said the Federal Reserve needs to get long-term interest rates, such as mortgages, higher to cool the market and reduce speculation. Although the Fed has boosted its key short-term rate by 2 percentage points in the last year, mortgage rates last week were more than a half-point lower than a year ago, Freddie Mac, the government created mortgage lender, reported yesterday.



The average rate for a 30-year-fixed mortgage was 5.71 percent, compared to 6.3 percent a year earlier.



Long-term rates, such as mortgages, are tied to bond markets, which determine rates based on inflation expectations. So far, bond investors have remained sanguine about inflation and kept rates low. To push rates higher, Zandi said, the Fed needs to signal bond investors that their inflation outlook may be too optimistic and get long-term rates higher.



''The housing market is through the roof, way outside anything we've seen historically," he said. ''The longer it goes on, the more significant a correction we'll see."