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Home Price Analysis for Birmingham, AL
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 Birmingham-Hoover 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.
Nationwide, there has been an increased use in exotic mortgage loans of interest only and adjustable rate mortgages. Though, such data are not readily available for the local market, it is likely following this national trend. Therefore, rising interest rates will place some homeowners in greater risk of default. But the risks are mitigated from recent healthy job gains. Given the favorable housing affordability, significant gains in home prices are certaintly possible, particularly if the job market improves.
Price Activity
The current price of $156,100 is 30% below the national average.
The median home price grew 7% in 2004 and by 14% in the past three years.
Past price trends have always been steady - neither declining nor rising very fast.
Home price is very affordable in light of favorable in-migration trend into the region.
Affordability
The ratio of price-to-income has been remarkably stable in the past 15 years. By this measure, there is certainly no price 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 well 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 after suffering large cuts in 2001 to 2003. After decent jobs gains in 2004, the latest 12-months showed a job reduction by 1,000.
The region added in the past five years an estimated 30,000 new housing units of which about 27,000 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 a bit oversupplied as the ratio is less than zero. With recent job gains (2004 to 2005) and the expected continued nationwide economic expansion, the jobs-to-new home ratio will likely steadily improve.
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 many top southern 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.
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 16% in combination with 17,000 job losses could lead to a price decline. Job gains do not help if rates rise higher.
Other 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 about 10,000 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 because of the low business and very affordable housing cost conditions.
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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