Home Price Analysis for St. Louis

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 St. Louis 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.
Prices have risen faster than income in the past year.

This increase is frequently cited to imply that there is a housing market bubble. But this ratio is a misleading measure in assessing bubble prospects. A more relevant measure is the mortgage servicing cost relative to income. This ratio is only minimally higher than the local historical average. It implies no widespread financial overstretching to purchase a home in the region.

Price Activity

The current price of $141,900 is about 30% below the national average.

The median home price rose 5.1% in 2004 and 21% in the past three years.

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

Local home prices are one of the most affordable in the country.

Affordability

The ratio of price-to-income is currently below the historical norm, which implies substantial catch-up potential.

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 well below the local historical average. Also, the current servicing cost relative to other metro markets is very low. It implies no widespread financial overstretching to purchase a home in the region and a capacity for much higher home prices.

Local Fundamentals

The job market has turned the corner. There have been 13,100 payroll job additions in the past 12 months to July.

An estimated 70,000 new housing units were added in the past five years.

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 a bit oversupplied as the ratio is under zero. The situation will improve as the job gains continue.

Other Factors

There is no good information regarding interest-only loans in the local market. But if it reflects a national trend of a higher usage of interest-only loans, then some homeowners could feel the pinch of higher rates over time.

The baby boomers in their peak earning years and have been active in purchasing second homes, which many consider their future retirement homes. The baby boomer impact could continue for another decade.

With the Florida market getting very pricey, perhaps some retirees may steadily look toward the affordable regions of the country.

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. For example, mortgage rates rising to 15.5% in combination with local job losses totaling 39,000 could lead to a price decline.

Various scenarios that could lead to a price decline of 5% are shown below.

Such scenarios are highly unlikely. Most credible forecasts predict the region will create at least 15,000 jobs over the next 24 months and mortgage rates will hover around 7% by the end of 2006, which bodes well for future price gains.

Even in the unlikely event of prices declining by 5%, most homeowners will maintain sizable equity build-up in their homes. The table below shows the home equity gains if prices were to fall by 5% by homebuyers at various years of purchase.

Housing equity will most likely continue to accumulate to local homeowners. The equity gains under three price growth scenarios are presented below. One scenario assumes a historical conservative price appreciation of 1.5% above consumer price index inflation. With most credible inflation forecasts pegged at 2.5%, home prices can expect to rise by 4% per year under normal circumstances. The two other scenarios assume slightly below (1.5%) and slightly above (6.5%) the normal rate of appreciation.

The local market is more likely to appreciate at an above-normal rate from being significantly affordable in comparison to other metro markets.

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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