Strategy

Is the Real Estate Boom Sustainable?

''June's record breaking pace,'' writes one analyst, might very well serve ''as a top'' to the recent surge in home sales.
Ed ZwirnJuly 28, 2004

The June run-up in sales of existing homes, to a record 6,950,000 annualized units, may have rekindled concerns that a real estate bubble may be ready to burst, but don’t look for housing prices to drop just yet, according to Moody’s Investors Service.

Home sales last month were 17.4 percent higher than the year-ago period, and numbers for the second quarter were 15.3 percent higher than for the second quarter of 2003. But “June’s record breaking pace,” writes Moody’s analyst John Lonski, might very well serve “as a top” to the recent surge in home sales.

According to Lonski, the continued loose monetary policy of the Federal Reserve will continue to prop up home prices. “A run-up by mortgage yields that exceeds what is warranted by economic fundamentals serves as the most likely trigger for a significant lowering of home prices,” he wrote. “By our estimate, the 10-year Treasury yield would have to quickly jump up from its current 4.5 percent to 6 percent if home price deflation is to menace the U.S. economy. A 6 percent 10-year Treasury yield would imply a 30-year mortgage yield of 7.5 percent to 7.7 percent.

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Since the Fed is aware of “the acute sensitivity of home prices to interest rates,” continued Lonski, it will probably hike interest rates “with caution” and probably be willing to “tolerate a somewhat higher rate of inflation than otherwise.”

The only remaining possible trigger for serious home-price deflation, added Lonski, would be unlikely, albeit catastrophic: “A major sell-off of U.S. Treasury securities by foreign bondholders.”