Foundations firm despite tremor

It has been a rough year for real estate investors. House prices and sales continue to drop, and developers from Boston to Las Vegas are cancelling construction projects. But as bad news piles up, investors should remember that slumps can be a good time to buy.

The National Association of Realtors last Thursday said home prices dropped 2.7 per cent in the fourth quarter of 2006 from a year earlier, after gaining 12 per cent in 2005. In cities such as Miami, where speculators drove prices up 27 per cent in 2005, values fell 6 per cent. The market is clearly in the middle of a correction.

“We still have a rocky road across the next few months,” says Frank Nothaft, chief economist at mortgage agency Freddie Mac. He expects prices to bottom in 2007, but adds any recovery this year will barely outpace inflation.

Investors nervous about buying during a correction should take comfort in economics.

While most housing slumps result from economic slowdowns, this one simply cooled a scalding market after excessive demand had pushed prices out of buyers’ reach. Firm gross domestic product, affordable interest rates and low unemployment should boost the market again.

Demographics are helping. The proportion of Americans who own their home has risen steadily in the past century and now tops 60 per cent, even as the population grows by 3m each year. Aging baby boomers – the 78m who make up the wealthiest generation ever – are spending lavishly on second and third homes.

“The boomers are expecting to live a long time,” says Patrick Lawler, chief economist at the government’s Office of Federal Housing Enterprise Oversight. “They are still 60 or less, so their need for housing will continue to be strong.”

Before making a down-payment, however, keep in mind population changes are redrawing the housing landscape. The increase in retirees and the influx of immigrants who settle in gateway states have slowly pushed demand for housing to the south and west.

As a result, cold states such as Michigan and Pennsylvania that once tied residents down with manufacturing jobs will lag, while Texas and Oregon are considered smart bets.

The West: A region fuelled by migration

Americans have been migrating west since the 19th century, creating a sizeable part of the country’s mythology along the way, and the trend continues today. California’s rallying housing market has sent ripples across the region.

“Utah, Colorado and New Mexico are benefiting from the residual impact of the California market boom,” says Lawrence Yun, senior economist at the National Association of Realtors, pointing out that Nevada and Arizona caught the first wave of spill-over earlier in the decade and rose sharply during the boom.

Although speculators drove some of the price gains in the west – in Las Vegas, for example, home prices almost doubled between 2002 and 2005 partly due to rampant condo construction – markets have generally been supported by an influx of immigrants from Asia and Latin America, says Mr Nothaft.

“Immigrants tends to settle in the gateway cities in the west and south,” says Nothaft, pointing out that Asian and Hispanic immigrants have bolstered demand and economic growth in cities across the western coast. Prices in both Portland, Oregon and Seattle, Washington rose 11 per cent in the fourth quarter of last year.

Large cities in California, meanwhile, have been affected by local trends.

Los Angeles remained firm in the correction – up 3.2 per cent in the fourth quarter – partly due to local zoning laws capping new developments, says Mr Yun.

San Francisco, which boasts the most expensive homes in the country (the median house there sold for $736,800 last year) has also held up well. “There’s been a resurgence in technology and the internet, and the job market is coming back very strongly there,” says Mr Yun.

“They’re already the most expensive, but you could see respectable price growth of
4-8 per cent in 2007. I think they will certainly do better than the national average.”

Midwest: Manufacturing gloom

Midwest real estate performed poorly both during the boom and the correction.

Large parts of the region, including most of Michigan and sections of Illinois, Indiana and Ohio, were battered by the ongoing troubles in the Detroit auto industry. Michigan’s job market has shrunk every year since 2000, and home prices in Detroit dropped 7.4 per cent last year.

“Draw a circle around Detroit and go out two and a half hours,” says Jonathan Nicholas the regional head of RE/MAX Indiana, describing the area investors are advised to avoid. In Toledo, Ohio, for example, home to many automotive suppliers, prices dropped 6.2 per cent last year. Chances for a recovery are slim. “I wouldn’t invest in Michigan as a personal primary residence,” says Mr Nicholas.

Other parts of the Midwest have been chugging along nicely, though. Chicago, which usually mirrors national trends, has been spared from the auto industry fallout by a strong economy. “Chicago is much less dependent on manufacturing and more reliant on the financial sector, which is doing particularly well,” says Mr Nothaft.

Coming in much cheaper than comparable cities – the median home sells for $268,100 compared with $464,400 in New York – Chicago’s outlook is supported by the migration of young professionals who have been priced out of the market elsewhere.

The South: Mostly sunny, with showers in Florida

A variety of trends affect the south. Broadly speaking, it offers some of the best investing opportunities due to relatively cheap homes and a booming population. Florida is the big exception. “Prices there skyrocketed for three of four years, and some people think it’s too pricey,” says Mr Yun. “They’re looking for alternatives.”

Miami home prices rose 90 per cent between 2002 and 2005. Now, hundreds of developments have been converted into rentals or remain unsold.

And because Florida often experiences hurricanes, insurers have raised premiums, further increasing the cost of home ownership. Experts say it is best to stay away from Florida until the market stabilises.

Homebuyers priced out of Florida have started heading north. Many retirees have settled in South Carolina, where beachfront retirement communities have sprung up at Myrtle Beach and Hilton Head. North Carolina has attracted young families and Hispanic immigrants. “We’re one of the fastest-growing states in the nation due to immigration and migration,” says Eb Moore of Coldwell Banker in Cary, North Carolina. In Raleigh, one of the more popular cities in the state, home prices rose almost 10 per cent last year. Both Carolinas are expected to continue outperforming the rest of the country in coming years.

Texas is another southern favourite tipped to do well, especially if energy prices remain firm. Home values didn’t spike much during the rally – Houston and Dallas both gained less than 10 per cent between 2002 and 2005 – despite strong economic growth, and are now expected to catch up. “Texas home prices are below the national average by about 10-15 per cent,” says Dave Jenks, author of the The Millionaire Real Estate Investor and senior market analyst at Keller Williams Realty. “We’re starting to climb back up toward it.”

Most experts are reluctant to make predictions on New Orleans. They say it is unclear whether the city will ever regain its pre-Hurricane Katrina stature, and point out that construction workers and other temporary residents are inflating current prices.

North-East: Sharp gains cut by steep correction

The north-east reported the strongest gains during the boom and has been hit hard in the correction.

In Washington DC, for example, prices for single-family homes dropped 2.6 per cent last quarter after gaining 76 per cent between 2002 and 2005. Prices will rise only slightly this year, predicts Michael Rankin of Sotheby’s International Realty in Washington DC. New condominium developments, which flooded the market during the boom, are likely to underperform. Properties in older neighbourhoods with limited supply, such as Georgetown, are expected to hold up well.

Lagging economies pulled down some cities, particularly in New England. Boston, for example, which relies heavily on technology jobs and is still recovering from the dotcom meltdown, underperformed during the property boom and the declined 2.6 per cent last year. As in other markets, the upper segment of the market has done best. “We’re seeing a flight to quality,” says Jason Weissman of Boston Realty Advisors.

The outlook for New England is dim, says Mr Nothaft. “We’re seeing very weak employment and income gains,” he says. “We’re going to see a continuation of a relatively weak housing market.”

Interestingly, some cities that outperformed the rest of the country during the boom continue to prosper through the correction. New York and its surrounding suburbs, for example, where house prices jumped 42 per cent during the boom, have benefited from strength in the financial industry. Prices in New York, and nearby sections of New Jersey and Long Island rose 2.3 per cent in the fourth quarter. “New home construction has been limited, and population growth has been strong,” explains Mr Yun. New York is expected to rise further as long as the financial sector remains firm.