NEW YORK CITY’S HOUSING BUBBLE, 2005-2006

NEW YORK CITY’S HOUSING BUBBLE, 2005-2006 • Presented by John Tepper Marlin, Principal, CityEconomist.com, NYC, at the Eastern Economic Association, Philadelphia, February 23, 2006. • Updated from work of the economic unit of the NY City Comptroller’s Office, September 2005. Economic Unit: John Tepper Marlin, Chief Economist; Farid Heydarpour, Principal Economist; Irina Livshits, Economist; Julian Harper, Intern (Swarthmore College).

Housing prices in New York City have been rising rapidly • Is there a bubble? How do we know? • Is there is A Bubble Checklist (ABC) test that could be applied to any city? • If there is a bubble in NYC, why did it happen? • What are some post-bubble scenarios (PBS)?

U.S. housing market hot: 15% increase in mid-2005 • Median price for existing U.S. homes, mid-2005: $219,000 • 15% above a year earlier • Fastest rate of growth in 25 years • What about NYC?

Manhattan apartments soared faster, 30% increase in 2Q05 • Coop & condo mean prices rose 30% from year earlier… • … 8.5% from 1Q05… • …to a record $1.3 million. • Mean prices of apts. with 4+ bedrooms rose 113% over year earlier, from $5 mil. to $10.6 mil. • (But 4+ bedroom apts. were < 2% of coop/condo sales in 2004.)

A Bubble Checklist (ABC): Three Tests for NYC (A) Have NYC Housing Prices Grown Faster than the NYC CPI? Housing prices historically have kept pace with overall inflation. (B) Have NYC Housing Prices Grown Faster than Personal Incomes? Higher housing prices must over time be supported by higher incomes. (C) Are NYC Mortgage Payments Higher than Rents? Rents typically move in tandem with home prices.

Test A. NYC Housing Prices Grew Faster than NYC CPI • NYC shelter prices (BLS-imputed rent = cost of housing & maintenance) from 2/2001 to 6/2005 rose 21%. • More than 7 %age points faster than NYC CPI growth of 13.7%. • NYC’s cost of shelter has exceeded U.S. cost since early 2001 (Chart 1). Sign of a possible bubble.

Chart 1. Growth in Shelter Cost and CPI, NYC, 1/00-6/05 Source: BLS

Test A. Sidebar Query: Is Shelter CPI Underestimated? • Since 12/04, NYC’s cost of shelter has averaged 4.7%, two full %age points above the nation’s 2.7%. • Shelter cost is 32.9% weight in CPI; explains why NYC inflation > U.S. • Question: When rents lag sales prices, does “shelter” cost understate NYC/U.S. housing inflation? If so, the bubble could be bigger than it looks.

Test B. NYC Housing-Price Growth > Personal Incomes • Median real price of NYC housing jumped to $313,867 in 2003 from $231,922 in 2000, a 35.3% increase.ACS. • But NYC per capita personal income rose only 2.5%, to $40,899 in 2003 from $39,915 in 2000.BEA. • In 2000-2004, the median price for a single-family NYC home rose 71.5%, but average wage rates, a major component of personal income, rose only 9.6%. NYS (PI 2004 n.a.) …

Test B. NYC Housing-Price Growth>Personal Income(Cont.) • Average NYC wage rates in 2000-2004 grew 9.6%NYS (PI 2004 n.a.) but • Manhattan condo & coop prices grew much faster: - Mean sales price rose 70.8% (to $1,004,232 from $710,788). Prudential - Median sales prices rose 51.8% (to $605,859 from $399,000). Prudential - Mean price per square foot rose 46.9% (to $767 from $522). Prudential • …Which adds up to signs of a bubble.

C. NYC Mortgage Payments Greatly Exceed Rents • A 5.5% mortgage means a monthly payment on a median-value NYC house ($313,867) of $1,782, more than 2X median NYC rent ($816). Most recent data 2003. • The 2003 median monthly rent would pay for a mortgage on only $143,715, less than 1/2 median home value. • The nominal 5.7% increase in 2003 NYC median rent over 2000 rent ($772) is 1/6 of the real increase in median NYC house price. Signs of a bubble.

Why Did Housing Prices Rise? 1. More Demand? Not in NYC • Population in NYC didn’t grow fast – just 1%, from 7.8 million in 2000 to 7.9 million in 2003. • Income in NYC didn’t grow fast – per capita personal incomes of NYC residents rose just 2.5%. • Employment in NYC actually fell 5.1% from 2000 to 2003 & remained 4% below 2000 level in 2005. • Foreign buyers may have contributed to demand for NYC housing because the value of the $ in 2005 was 1/3 below its peak in October 2000.

2. Is There a Shortage in NYC Housing Supply? Possibly. • No. of NYC housing units grew slowly in 1970s and 1980s, limited by scarcity & cost of NYC land & zoning/code hurdles. • But Giuliani & Bloomberg eased hurdles. • NYC housing construction cost rose only 4.8%, to $125.91/sf in 2003 from $120.20/sf in 2000. • Cost rose to $132.18/sf in 2004, for an increase since 2000 of 10%. Source: Dodge Analytics, McGraw-Hill Construction Data.

2. Housing Supply Shortage? Possibly (Cont.) • In 2000-2003, NYC housing units grew 1.6%, faster than population growth…Source: U.S. Census, CPS. Grew from 3.20 to 3.25 mil. units. • … and housing permits outpaced growth in households.NYC Rent Guidelines Board, Housing Supply Report, 2005, June 2, 2005, 2. • In 2004, 24,220 permits were issued, the most since 1972.NYC Dept. of Finance, “Building Permits by Type,” NYC Property Tax, FY 2005, 40. Permits were for “new construction.” • Net supply: Enough to contain price increases, provided units not taken off the market. Source: Steven G. Cochrane, “Real Estate Activity Index,” Regional Financial Review, June 2005, at www.economy.com.

3. Availability & Cost of Home Financing? Yes… • The best explanation of rising NYC housing prices: The 30-year mortgage rate fell. • This boosted the power to buy a home. Back in 2000, financing the median NYC home (price = $209,900) with a 30-year fixed 8.04% rate meant a monthly payment of $1,548. • A 2004 buyer with a 5.78% mortgage could incur the same monthly payment on a mortgage of $264,057, a 26% increase in buying power. (See Chart 2.)

Chart 2. Mortgage Rates & Home Buying Power 01-04

…But Home-Price Growth Exceeds Lower-Rate Benefit • Housing prices grew faster than can be explained by lower mortgage rates. • The benefit since 2002 from lower rates explains $260,000 of the price difference. • The remaining $100,000 increase is not explained by economic factors. • This suggests psychological factors have played a part, i.e., a bubble. (See Chart 3.)

Chart 3. NYC Home Prices & Home Purchasing Power

Prospects for U.S. Cooldown • Housing markets may be cooling off. • Long-term interest rates have stayed lower than most economists expected given continuing large Federal budget deficits, the steadily rising fed funds rate & the revaluation of Asian currencies. • However, as the fed funds rate has risen, long-term interest rates—including mortgage rates—have also started to rise. Source: Data from www.bankrate.com.

Prospects for U.S. Cooldown (Cont.) • With a fixed-rate mortgage, each 1 %age-point increase in rates translates to a decline of about 10% in the principal financed with a given payment. • With a variable-rate mortgage, each 1 %age-point increase in mortgage interest rates means an 11% rise in monthly payments. • Without a spurt in incomes, this will put downward pressure on housing prices. Source: Calculations by NYC Comptrollers Office.

U.S. Cooldown Scenario 1: Less Consumer Spending • People who own their homes cannot sell them as fast as they can sell securities. • But people tend to reduce spending faster when house prices fall than when the price of securities falls. • Homeowners are also paying more for energy. Paying $1,200 more for heating oil & electricity is equivalent to a 5.5% mortgage payment on a $17,600 30-year mortgage. So other spending may be crowded out by higher energy costs.Source: NYC Comptroller’s Office.

U.S. Cooldown Scenario 1 (Cont.) • For every $1 decline in the value of their holdings of stocks & bonds, consumers reduce spending 3-4 cents. • For every $1 decline in housing assets, they reduce spending 5-7 cents. • So a housing-price decline would significantly reduce consumption, which is most of GDP. Sources: Karl E. Case, John Quigley, & Robert J. Shiller, “Comparing Wealth Effects: The Stock Markets versus the Housing Markets,” NBER Working Paper, October 2001. Wealth effect is cited as 7% for housing assets by Stephen Roach, “The Asset Economy,” Steve Roach Weekly Commentary, Morgan Stanley, June 21, 2004, 3. The wealth effect is cited as 5% for housing assets by Richard W. Peach, “Are Home Prices the Next Bubble?”, Economic Policy Review, Federal Reserve Bank of New York, December 2004, 2.

U.S. Cooldown Scenario 2:Debt Stress, Foreclosures • “Flexible financing” has risen – mortgages with no down payment or proof of income, or interest-only. • Mortgage market riskier for lenders. • Borrowers could lose their homes to lenders or have to sell in a hurry. • Rising home-equity & other adjustable-rate mortgages are vulnerable to higher mortgage rates.

U.S. Cooldown Scenario 3: Capital Market Stress • In 2003, the Office of Federal Housing Enterprise Oversight (OFHEO) & Fed voiced concerns about risks facing Fannie Mae & Freddie Mac. • These government-chartered but private companies buy mortgages from lenders & sell them to investors. (Only Ginnie Mae is government-backed.) • If housing prices stagnate or decline, Fannie and Freddie will face losses & stress could follow in capital markets. Sources: Office of Federal Housing Enterprise Oversight (OFHEO), Systemic Risk: Fannie Mae, Freddie Mac & the Role of OFHEO, February 2003. Alan Greenspan, “Letter to Rep. Richard H. Baker (R-LA),” May 19, 2000. Greenspan, Testimony to the Senate Banking Committee, June 15, 2004.

U.S. Cooldown Scenario 4: Fewer Real Estate Jobs • Real-estate-related jobs have grown in construction, banking, insurance. • These & other sectors will be affected as housing markets cool. • First effect could be decline in volume of sales rather than prices. Sellers may prefer to wait, hoping prices will recover. (With inflation, nominal prices will rise eventually.)

NYC Cooldown Scenario 1: Reduced Consumer Spending • Cooler NYC housing market implies a moderate reduction in spending. Growth in NYC housing prices, 77% in five years, less rapid than in Santa Barbara, 122%; San Diego, 118%; or Miami, 96%. PMI Group, Walnut Creek, CA • Underlying value of homes in metro NYC housing prices estimated 25% above sustainable level; Santa Barbara 69% above. Data for the 1Q05: Richard J. DeKaser & John G. Charamonde, “House Prices in America,” National City Economics (Cleveland, Ohio), July 2005.

NYC Cooldown Scenario 2: Some Mortgage Banking Stress • Problems with payment on home-equity loans likely. • But effect in NYC not likely to be as great as in other cities where mortgage practices are riskier. • One reason: Coop boards in NYC review financials and limit borrowing for purchase.

NYC Cooldown Scenario 3: Capital Market Effect • If regional housing bubbles burst with unexpected speed, capital markets may be affected because mortgage risks securitized by Fannie Mae & Freddie Mac may flow through to shareholders in these companies. • Disruption in these markets could be damaging for NYC, which depends heavily on Wall Street incomes.

NYC Cooldown Scenario 4: Real Estate Income Losses • Cooling of housing prices will reduce jobs and incomes in NYC’s real estate and finance industries. • However, jobs already declined in these sectors in 2000-2004, so the impact may be primarily on incomes, not jobs. • Some construction jobs appear to have migrated to the informal economy. The impact of a decline in demand may be informal.

Outlook for 2006: Higher Rates a Problem for NYC • Interest rates (10Y Treas.) projections average 4.8% from 4.3% in 2004-2005; Bear Stearns at 5.2%. Will hurt housing prices and Wall Street profits/bonuses. • NYC “Misery Index” for 2006 projected 9.4% = 3rd highest unemployment, 5th inflation & > 7.8% U.S. • Mayor projects NYC GCP growth in 2006 at 2.1%, lower than 3.3% U.S. Source: Misery Index for 3Q05 – NYC Comptroller’s Office, 2005. Projected 2006 GDP growth and U.S. misery index are based on Feb. 10, 2006 Blue Chip consensus.

NEW YORK CITY’S HOUSING BUBBLE, 2005-2006