Housing Market Set for a Leak, Not Bust

Tuesday July 27, 9:12 pm ET
By Ilaina Jonas

NEW YORK (Reuters) - For over a year, headlines warned of a U.S. housing bubble and the inevitable bust.
But home builders have kept setting records constructing new homes. And prices of new homes in some areas continued rising -- 20 percent higher in some areas than they were last year.

So where's the bust?

It's missing in much of the government's official housing data. On Tuesday, the U.S. Commerce Department said sales of new homes dipped to a seasonally adjusted annual rate of 1.326 million units in June -- down 0.8 percent from a record pace of 1.337 million units in May.

Once again, the housing sector defied economists' expectations for a drop-off. The new home sales figures came a day after the National Association of Realtors (News - Websites) reported that existing home sales jumped to a record high in June.

But the data hasn't changed housing analysts' minds.

Unlike the stock market, where the tech-loaded Nasdaq Composite Index (NasdaqSC:^IXIC - News) lost 37 percent in just three months in 2000, the housing market won't suddenly pop, experts said.

Instead, it will deflate as if it sprung a slow leak.

"The stock market focuses on bubbles because that's what happens in the stock market. It just collapses," said Natexis Bleichroeder analyst Barbara Allen. "That isn't what happens in the housing market. You get some markets where you will get price declines. That's happened in the past in California and in the Northeast, and I think we'll have it again, over a period of a couple of years, though."

Allen said there already are pinhole leaks.

FIRST-TIME BUYERS HURT

"The first signs that we've seen of it has been the Midwest and companies focused on first-time home buyers," she said, referring to Dominion Homes, Inc.(NasdaqNM:DHOM - News), whose sales volume dropped 44 percent in the second quarter.

"You're starting to see the impact of higher rates on the first-time home buyers," Allen said. "If you get rates that go up, it will be more difficult for them to qualify."

While still near the lowest levels in a generation, mortgage rates are a little more than half a point higher than their March nadir.

In June, U.S. sales of new homes fell 14.2 percent in the Northeast and 13.1 percent in the West, according to the Commerce Department statistics released on Tuesday.

HSBC economist Ian Morris said that with home sales setting record highs in May and June, the downside in the residential real estate market is about a year away.

"The timing of it is difficult," Morris said. "But by the middle of 2005, the party will be over."

Prices are 10 percent to 20 percent too high, he said.

THE FED GIVETH ... AND TAKETH

The Federal Reserve created the housing boom by driving U.S. interest rates to 46-year lows, and the Fed also will be the architect of the housing slowdown with its current policy of rising rates, Morris said.

The fallout from the stock market crash of 2000 and the subsequent three-year bear market will look tame compared with a decline or even a leveling off of housing prices, Morris warned, because more people have more of their wealth tied up in their homes than they did in the stock market.

"Some academic studies suggest that the negative housing wealth effect could be more than twice as powerful as an equity wealth effect because your average person owns a home, but doesn't necessarily own that much stock," he said.

Many experts said the areas at most risk are the hot spots of the New York, Boston and Chicago metropolitan areas, and above all, California, where the median cost of an existing home in June rose to a record $469,170 -- up $100,000 in a year. In May, when the median price was slightly lower, only 19 percent of households in the state could qualify to buy a median-priced home, Allen said.

But Morris said the risk is spread nearly nationwide.

"I get 20 states plus (Washington) D.C. looking pretty rich compared to their histories, and that accounts for half the population," he said. "It's a bit more than a few local bubbles here and there."

Keep a Running Tab Before Selling Your Home

Tuesday July 27, 7:04 am ET
By Ann Perry, Senior Writer

Thanks to the big appreciation in home prices, many homeowners are making a bundle when they sell.
What's more, most will get to pocket those profits tax free -- up to $250,00 if single and up to $500,000 married -- as long as they have lived there for at least two of the past five years, courtesy of a 1997 law excluding most capital gains on principal residences from taxes.

Still, a small, but growing, number of upper middle-class and affluent homeowners in pricey markets along both coasts are beginning to exceed the generous limits of the law and will have to pay capital gains taxes on the excess, according to tax and real estate experts.

The tax of 15% or 5%, depending on the seller's tax bracket, can be reduced or eliminated with good tax planning and careful record keeping. For some taxpayers, the tax can even help wipe away any large, painful stock-loss carry forwards of the past several years.

W.G. Spoor of Spoor Doyle & Associates CPA in St. Petersburg, Fla., says he recently worked with one client who bought a two-bedroom, two-bath condominium in Manhattan near Central Park in the late 1990s for $200,000. The man recently sold it for $700,000.

"He was strictly buying in the right place at the right time," says Spoor. That was the good news. The bad news was that he made such a big profit, not all of it was tax free.

The tax calculations go like this: His basis (the original price plus expenses used in calculating capital gains) in the property was the $200,000 he paid for it, plus $50,000 for remodeling the kitchen. That $250,000 was subtracted from the $700,000 sales price for a gain of $450,000. After subtracting his $250,000 capital gains exclusion for single taxpayers, the seller had $200,000 in taxable gains. For most people in this situation, those in the highest tax brackets, the capital gains rate would be 15%.

Linda Goold, tax counsel for the National Association of Realtors, or NAR, said the association is aware that rapid price appreciation in a small portion of the nation's housing stock is causing home sellers to exceed the 1997 exclusion threshold.

"We know that it's a problem, that it's out there," she says. "We were disappointed when Congress initially passed the law, that they didn't index it for inflation."

In the first quarter of this year, 5.4% of homes sold nationwide were priced at more than $500,000 and 25.8% cost between $250,000 and $500,000, according to Walt Molony, an NAR spokesman. It's impossible to tell, of course, how many sellers exceed the exclusion thresholds without knowing the basis in the homes.

Many people who are near the threshold can avoid going over it simply by keeping good records on their homes for the purpose of establishing the tax basis.

Mark Luscombe, principal analyst at tax-law research company CCH, says that basis is what the homeowner paid for the property, the selling costs and capital improvements.

The Internal Revenue Service does not consider routine maintenance like painting or replacing carpeting to be an improvement. Rather, it is anything that extends the life of the home, such as a new roof, electrical system, heating system, siding, or a new fixture like a bathtub or toilet. This also includes new windows, major landscaping such as trees and in-ground swimming pools.

Spoor, the Florida CPA, has worked with one couple who are preparing to sell a waterfront home they bought decades ago for $70,000 in a neighborhood where houses now go for $1.4 million and up. They plan to buy a less expensive home and use the balance to help finance their retirement.

"We've tried to put together a list of all the improvements," he says, acknowledging it will be difficult for them to avoid paying some taxes. "We try to get the basis as high as we can."

Luscombe says it best: If possible, keep a permanent file and update it regularly, as he does: "I just keep sort of a running tab on my basis."

All records should be kept for at least three years after the home is sold.

Henry Strohminger, president-elect of the Baltimore Board of Realtors, where home prices have experienced double-digit appreciation for the past three years, tells all his clients to keep good records on their homes.

"It's the biggest purchase people will make in their lifetime," he says. "Why shouldn't they keep good records?"

Michael Eisenberg, CPA, PFS with Michael Eisenberg Accountancy Corp. in West Los Angeles, says he reminds clients every year to monitor the basis in their homes. With real estate prices continuing to soar this year, several clients have exceeded the exclusion limit when they sold.

One married couple with two children, one in college and one in high school, wanted to move down to a less expensive home from a house on a large piece of land that was costing them dearly to maintain and use some of their gain to help defray college expenses.

In some cases, Eisenberg has advised clients who took big stock losses in the past few years and are still carrying them forward to apply them against the gains that exceeded the home exclusion limit.

"Now those losses will be offsetting the gains on the house," he says. "It erases the burden of the losses from years ago."

Eisenberg offers one note of caution for taxpayers who've owned their homes since before 1997. If they owned at least one other house before the one they're in now, they might have to take into account some aspects from the previous law, which required homeowners to carry their gains with them from home to home before finally taking one lifetime exclusion.

The upshot, he says, is "potentially you could have more gain built up than you thought." They might want to consult a tax professional before selling.

But Eisenberg doesn't hesitate to encourage clients to go for their $250,000 or $500,000 in tax-free money. After all, the law allows them to buy another house and do it again.

"Avail yourself of this wonderful, wonderful law," he says. "This is a good one."

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Boom in home sales is summer surprise

Neal Gendler
Star Tribune
Published July 13, 2004

Home buyers fearing higher interest rates took advantage of the continuing flood of listings last month to create the strongest June on record and set a third consecutive monthly record for median price: $220,000.

The 7,047 sales closed last month were up 26 percent from May and a 19.3 percent increase from 5,905 in June 2003, according to Regional Multiple Listing Service data reported Monday by the metropolitan area associations of Realtors.

"The June statistics surprised everybody," said Ann Brockhouse, president of the Minneapolis Area Association of Realtors. "Last June was just phenomenal, and we never thought we would surpass that, but we did in every category."

In addition to the usual seasonal preference for moving in the summer, sales appear to have been spurred by "lots of hype about interest rates going up," said Brockhouse, who is sales manager of Roger Fazendin Realtors. "That put a little urgency into buyers in April and May."

All that buying not only led to a record median -- the price with half selling for more and half for less -- but it sent the value of closed sales past $1.8 billion, 35 percent ahead of May and up 27.73 percent from June 2003.

"Buyers' perception that the Fed adjusting the rate up a quarter percent has something to do with mortgage interest rates pushes them off the fence," said John Lockner of Re/Max Results and president of the St. Paul association. "Mortgage rates are tied to Treasury bills, but buyers don't realize that. Actually, mortgage interest rates went down."

National data from mortgage funder Freddie Mac show average 30-year rates fell to 5.38 percent the week of March 18 before peaking at 6.34 percent the week of May 13.

Rates fell again to 6.25 percent the week of June 24, just before the Federal Reserve raised short-term rates a quarter point on June 30 and have continued to fall since to 6.01 percent last week.

Sales closed represent purchase agreements signed weeks earlier, so most closings in June would have been for transactions begun in April and May. At June's end, 6,510 transactions remained to be closed, 1.07 percent more than the number a year earlier. Inventory remained strong, with 31,156 properties listed, nearly 26 percent ahead of June 2003.

For the first six months, 26,362 sales closed, up 7.19 percent from the first half of 2003. The value of those sales was $6.5 billion, up 14.98 percent from $5.7 billion a year earlier.

Strong sales have led the National Association of Realtors to revise its forecast for 2004 from the second-best ever to the best, with 6.31 million existing-home sales, up 3.4 percent from 2003. Brockhouse said local Realtors now expect a fifth consecutive annual sales record.

Rising prices don't seem to be curbing demand, and the bottom end of the market has been surprisingly slower, said Gregg Roeglin of Edina Realty, president-elect of the Minneapolis association. By contrast, the $250,000-to-$300,000 range is very active, despite fewer listings than homes at the lowest prices, he said.

For example, he listed a two-bedroom, two-bath Burnsville condo for $112,500 last October, expecting it to be snapped up in a couple of weeks.

But it sat, and the price was dropped to $109,900 in early January. The home had new carpeting, appliances, cabinets and paint, but it didn't sell until the seller paid a buyer's closing costs, reducing the net to about $103,000, said Roeglin.

Roeglin said he was surprised by the paucity of interested buyers. Of those who did look, many ended up buying elsewhere in the $150,000 range. "Buyers have been gravitating upward in price, and the low-end properties have been taking longer and longer to sell," he said.

"Even a year before, you'd hold an open house and take the bids. My feeling is that with interest rates where they've been, it's very easy for most buyers to afford $150,000 to $200,000, so human nature being what it is, buyers decided to buy more."

Lockner said prices should remain strong the rest of the year because of rising land prices and population growth from relocation and immigration. He said new immigrants rent from people who may move out and buy, creating "a leapfrog situation" in which people sell and move up across several price ranges.