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Home Price Analysis for Baltimore, MD

With home prices rising strongly in most parts of the country, there has been widespread media coverage of the possibility of a housing market bust. A thorough analysis of the Baltimore�Towson 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.

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 only minimally higher than the local historical average. It implies that there is no 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.

A high usage of interest only loans and ARMS places a greater exposure risk to interest rate changes. But the risks are mitigated from recent job additions of more than 15,000 in the past 12 months. Also, prices are much more affordable than the nearby Washington market, which implies a greater price increase potential.

Price Activity

The current price of $264,700 is 30% higher than the national average.

The median home price rose 20% in 2004 and 75% in the past five years.

Home prices had been relatively flat for most of the 1990s. So part of the recent increase is attributable to the "catch-up" effect.

Affordability

Because the 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.

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 only minimally higher than the local historical average.

Local Fundamentals

Job gains have been robust in the last five years. A total of 29,000 jobs were added during that time. Many new job holders seek their own housing units.

The region added an estimated 52,000 new housing units of which 41,000 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. In our case, the local market is at a roughly neutral level as the ratio is slightly under one. (Note the housing surplus conditions in the early 1990s when there were more housing units being built relative to job creation. Such conditions largely explain the weak price movement for most of the 1990s).

Other Factors

Interest-only loans accounted for 19% of all loans. Therefore, some homeowners could feel the pinch of higher rates over time.

Baltimore-Towson partly serves as a bedroom community for D.C. workers. So the rising tide of the D.C. market generally helps the Baltimore-Towson market.

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 outer edges of the local market, being near mountains and ocean, could benefit from second-home purchases by baby boomers.

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 12.5% in combination with local job losses totaling 78,000 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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