Home Price Analysis for Farmington, NM

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 Farmington 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 at a very manageable level. 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 strengthens.

Price Activity

The median home price grew 7% in 2004 and by 27% in the past three years.

Despite the strong gains, the current price of $151,800 is 30% below the national average.

Prices declined in the late 1980s following the weak price conditions in Texas - related to Savings and Loans scandal and the collapse in the oil prices. Otherwise, prior to 2004, past price trends have been mostly steady - neither declining nor rising very fast.

Home price is very affordable in light of improving job market conditions and from 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 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.

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 will see 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 11.5% in combination with 3,000 job losses could lead to a price decline.

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, 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 rate of 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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