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Are Home Prices About to Stabilize?

By JOSEPH REBELLO
Dow Jones Newswires

WASHINGTON -- U.S. house prices are likely to grow at the slowest pace in more than three decades as interest rates climb and land prices take a tumble over the next three years, researchers at the Federal Reserve have estimated in a new study.

The study, published on the bank's Web site recently, asserts that if U.S. disposable income and short-term interest rates climb as much as Wall Street expects them to, nominal existing-house prices would increase a cumulative 2.6% over the next three years. That would mark the lowest rate since the government began keeping records in 1970. The number implies high odds that house prices will decline in inflation-adjusted terms.

The conclusions validate the unease of many private economists who fear the U.S. housing market, having benefited recently from rapid price gains that helped maintain strong consumer spending through a recession, may become a source of economic instability as interest rates climb. Prices of existing homes rose by more than 20% cumulatively over the last three years, according to the National Association of Realtors. The association has been predicting only a modest slowdown for the next few years.

"Of primary concern to some analysts is whether the recent run-up in aggregate home prices will be somewhat reversed, much like the 1985-90 and 1990-1995 experience," when inflation-adjusted house prices declined in several major metropolitan areas, write the authors of the Fed study, Morris Davis and Jonathan Heathcote. Mr. Davis is a Fed economist, and Mr. Heathcote is an assistant professor of economics at Georgetown University.

They conclude a reversal of those magnitudes -- involving land-price declines of as much as 10% -- is likely.