Housing Prices Are On The Rise Again, But Don't Get Caught Holding The Bag

Includes: FRI, ICF, ITB, IYR, PKB, XHB
by: Vahan Janjigian, CFA

Many parts of the economy continue to struggle, yet the housing market is showing signs of strength. According to the latest S&P/Case-Shiller numbers, existing home prices were up an average 1.4% in March from February across 20 major cities. They were up 9.3% from a year ago. These numbers are so strong, they have some analysts worrying about another housing bubble. Some realtors are even talking about bidding wars and encouraging prospective buyers to meet or beat the asking price. "Flipping" houses, a favorite pastime during the last bubble, is coming back in vogue in some parts of the country.

Stronger prices should not be that surprising. After all, housing prices had become extremely depressed and, thanks to an accommodative Federal Reserve, mortgage rates are at unbelievably low levels. Furthermore, as I explained in a June 2011 article in The Fiscal Times, it was inevitable that housing would recover once household formation contributed to pent up demand.

However, prices cannot continue appreciating at current rates for much longer- even if the employment market improves significantly. The long-run average rate of appreciation in housing prices is around 3.0-3.5%. Despite the recent gains, prices are still down almost 30% from their 2006 highs, yet if you measure them from January 2000, they are up about 3.0% on an annualized basis. In other words, the housing bust has taken us back to the long run average.

I don't doubt that housing prices will go higher. In the short run, they may even keep rising by higher-than-average rates. Soon, however, the gains must settle to somewhere near the long-run average. If they don't, regulators will probably take aggressive actions to make sure we don't create another bubble.

If you are thinking of buying a home and living in it for several years, I'd say go ahead. There's no time like the present. You'll probably never see better mortgage rates in your lifetime. However, if you are thinking of joining the flippers, you might want to think twice. No doubt some people will get rich flipping homes. Eventually, however, someone has to end up holding the bag.