Home Price Analysis for Richmond, VA

With home prices rising strongly in most parts of the country, there has been widespread media coverage on the possibility of a housing market bust. A thorough analysis of the Richmond metro market, as detailed below, reveals that there is very little danger of this. In fact, the local housing market is in excellent shape with a potential for significant housing equity gains, particularly for homebuyers who plan to remain in their house for the long run.

The local market has very favorable home price-to-income ratio and even better mortgage servicing cost-to-income ratio. The latter ratio is currently below the local historical average. It implies no widespread financial overstretching to purchase a home in the region. Any respectable gains in the local job market will translate into substantial home price gains.

A higher usage of adjustable rate mortgages (27%) will put some homeowners under stress when interest rates rise. But the risks are mitigated from the strong trends in migration and job gains. The region attracted 8,500 new residents arriving from other U.S. states in the past year. Furthermore, over 17,000 job gains in the past 12 months provide housing demand support.

Price Activity

The current price of $198,400 is right at about the national average.

The median home price grew by 10.4% in 2004 and by 41% over the three years.

Home price growth has been weak throughout the 1990s. So part of the recent increase is attributable to the "catch-up" effect.

Home price is very affordable in light of improving job market conditions. That means there could be much more upside potential, particularly if the job market gets on track as recent data appear to imply.

High home prices in the Washington, D.C. region may exert price pressures in nearby cities. Though Richmond is not near enough to serve as a bedroom community for D.C. and Northern Virginia workers, it could still experience some trickle effects.

Affordability

Because the prices have risen faster than income in recent years, the ratio of price-to-income has been rising strongly in the past four years. This measure is frequently cited to imply that there is a housing market bubble.

Mortgage rates declining to 45-year lows have been a major force in boosting home prices in recent years. Lower rates allow homebuyers obtain a larger loan without necessarily increasing monthly mortgage payments.

A more relevant measure for assessing the risk of a home price bubble is the median mortgage servicing cost relative to the median income. This ratio is currently below the local historical average. It implies no widespread financial overstretching to purchase a home in the region and a huge potential for a significant price gains.

Local Fundamentals

The job market has been improving. There have been 17,300 payroll job additions in the past 12 months. Many new job holders seek their own housing units.

The region added in the past five years an estimated 43,000 new housing units of which about 35,000 were single-family units.

The ratio of five-year job gains to five-year new home construction shows the "hangover" impact of the housing shortage, or housing surplus. In our case, the local market is essentially at a neutral level as the ratio is close to one. With recent job gains and the expected continued economic expansion, the jobs-to-new home ratio will likely increase.

Other Factors

ARMS and interest-only loans have risen across the country, including in Richmond where 27% of all loans in 2004 were with ARMS. Therefore, some homeowners could feel the pinch of higher rates over time.

The baby boomers are in their peak earning years and have been active in purchasing second homes, which many consider as their future retirement homes. The baby boomer impact will continue for another 10 to 15 years.

With Florida retirement destinations getting quickly unaffordable in the past five years, some retirees may turn to more affordable regions of the country. Perhaps, the local region gets a slight lift as a result, particularly given that historic Williamsburg and the ocean close by.

Stress Test

Price declines in the local market are unlikely according to our stress test.

The local housing market will experience a price decline of 5% only under extreme unlikely scenarios of much higher mortgage rates. For example, mortgage rates rising to 14.5% in combination with 29,000 job losses could lead to a price decline.

Additional Discussion Points

Home price declines are very rare. In fact, the national median home price has not declined since the Great Depression of the 1930s. Stock market collapses, the OPEC oil crunch, economic recessions, and even wars have not negatively impacted national home prices since the 1930s.

There have been few times when local prices declined. In nearly all these cases, the price declines were accompanied by sharp prolonged job losses. It is difficult to foresee a price decline in a job creating economy.

Homes trade far less frequently than financial assets (about one home sale every 7 to 10 years for most homeowners). There are also larger transaction costs associated with selling a home due to the lengthy careful examination demanded by home buyers and sellers. Therefore, home prices are not prone to fluctuations as in the stock market. There are neither panic sells nor margin calls associated with homes.

Many non-quantifiable factors could be important for this metro market in determining home prices. Access to cultural life, the quality of museums, nearby local and national parks, water views, exclusive neighborhoods, weather, the international airport, city vibrancy, restaurants, and a host of other non-quantifiable factors could have an important influence on the overall pricing.

There are immense tax benefits to owning a home. These tax considerations were not considered in the analysis. For example, the 1998 law permitting primary owner occupants to trade down without having tax consequences. Also most home sales results in no capital gains tax. In addition, long-term capital gains tax rates were reduced in 2003, thereby providing higher return for home investors. These positive benefits, if accounted for in the analysis, would have shown an even stronger case for housing fundamentals in supporting home prices.

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