Home Price Analysis for Honolulu, HI

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 Honolulu metro market, as detailed below, reveals that there is little danger of this. In fact, the local housing market is in excellent good with a potential for significant housing equity gains, particularly for homebuyers who plan to remain in their house for the long run.

Because prices have risen faster than income, the ratio of price-to-income is currently above the historical norm. This measure 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 at a very manageable level. It implies no widespread financial overstretching to purchase a home in the region. Furthermore, the nationwide supply of homes on the market relative to home sales is very lean, suggesting similarly tight market conditions in the local area.

Price Activity

� The current price of $577,800 is nearly three times the national average.

The median home price rose 21% in 2004 and 73% in the past three years.

Home prices declined in the 1990s coincided with the weakening of the Japanese economy. Similarly prices had risen strongly in the 1980s on the back of the rising Japanese economy.

Recent price gains can be attributed partly to the "catch-up" effect after the soft 1990s. Furthermore there are many people moving back and forth between Hawaii and California and the strong price increases in California is helping to lift local prices.

Affordability

Because the prices have risen faster than income in recent years, the ratio of price-to-income has been rising strongly. 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 near the local historical average, but not to the worrisome levels of the early 1980s or 1990s. It implies limited financial overstretching to purchase a home in the region.

Local Fundamentals

The job market has been exceptionally strong. There have been 12,400 payroll job additions in the past 12 months to July. Many new job holders seek their own housing units.

The region added in the past five years an estimated 14,000 new housing units of which 9,000 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 suffering from a housing shortage as the ratio has been rising fast and is well above one. With recent job gains and the expected continued economic expansion, the jobs-to-new home ratio could further increase.

Other Factors

ARMS accounted for 28% in 2004 across the region. Therefore, some homeowners will feel the pinch of higher rates over time.

However, only 6% of the loans have loan-to-value ratios above 90%, so the foreclosure risk is rather minimal. (That is, prices would have to decline by more than 10% to have a measurable impact on foreclosure rates.)

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.

� The region is a highly sought after region with mild weather and being on the Pacific Ocean. The local market will benefit from second-home purchases by U.S. baby boomers as well by wealthy foreigners.

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 7% in combination with 24,000 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.

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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