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Providence Business News, May, 1998

The housing market in Rhode Island has performed unevenly throughout this recovery. New home construction has remained well below the levels it attained in the last recovery. Until recently, the graph of Rhode Island’s single-unit housing permits revealed that permits were essentially "flatlining," stuck in the range between 2,045 and 2,400 units annually. At their peak in the last recovery, single-unit permits reached 4,800 units in 1987.

Fortunately for us, the housing market consists not only of new home construction, but of existing home sales as well. Sales of existing homes reached new highs in 1994, 1996, and again in 1997. So far this year, sales are running well ahead of their record setting pace last year.

The most critical positives that will determine the fate of the entire housing market over the next few years are interest rates and the overall level of economic activity. The negatives that we must be concerned about are debt and the demographics of the Rhode Island population. At the present time, falling interest rates have led to record numbers of refinancings, a major plus to both home sales and retail sales. And, our economy is doing better now than it has at any time in this recovery. The relevant question is how much longer these positives will continue to lead us forward.

The most informed answer at the present time is that these best of times will not extend much beyond this year. There is a good possibility that the Federal Reserve will raise interest rates before the end of 1998. History indicates that rate hikes usually extend to two or more increases, and market rates for mortgages and personal lines of credit generally increase by more than the amount by which the FED has tightened. Any slowing in the rate of national economic activity will further dampen housing momentum. Next year, I expect interest rates to be higher than they are at present and the pace of national economic activity to slow somewhat. Quite obviously, there is no compelling reason to anticipate that Rhode Island’s demographics, which are unfavorable to housing growth in general, will reverse. This leaves us with one primary positive going into 1999, the momentum of refinancings and the resulting "balance sheet adjustments" by Rhode Island families. While this last factor is clearly important, it will meet with considerable resistance as the other factors I mentioned offset its positive effects.

As the result of these forces interacting, I anticipate single-unit housing permits to rise by about 2 percent in 1998, breaking the 2,300 plateau. When the economy slows next year, I see permits dropping back into what has become their "sustainable range," between 1,950 and 2,100 units annually. Two other impediments preclude any trend toward substantial growth in permits. The first of these is the adoption by towns such as the one I live in (South Kingstown) of ordinances that place restrictions on the number of permits that can be granted in a given year. The other, which has a more far-reaching long-term effect, is the increasingly scarce number of sites in this state where new home construction can take place.

The news is better for existing home sales, since they are affected differently by the negative and positive forces I outlined. I project 1998 to set yet another record for existing home sales, the last for several years. After 1998, I see existing home sales fluctuating within the range of 5 to 10 percent below their levels in 1997. That might seem a bit optimistic. My primary basis for this expectation is the anticipated behavior of the median sales price of existing homes.

The median sales price for existing homes, which fell dramatically from its level at the height of the last recovery, eventually stabilized, and has recently begun to show signs of life. While most people view the median sales price as being flat for throughout this entire recovery, this is not really true. When viewed as economists analyze it, after adjusting for inflation, the real median sales price has actually been declining for some time. Thus, the affordability of existing homes has been rising for a while, independent of refinancings. This helps to explain why so many existing home sales records have been set during this recovery.

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Over the next few years, I see median sales price growth rising, not as the result of a continually rising number of home sales, but from accelerating inflation and greater representation of higher-end homes among those sold. But, even with this long-anticipated growth in median sales prices, the trend in real home prices will continue to be downward, as the graph shows.

So, one of the anomalies of this recovery is projected to continue: new home construction will remain largely absent from the economic landscape. The housing strength we will increasingly come to rely on is the sale of existing homes. The favorable impacts of declining real home prices, "balance sheet adjustments" resulting from lower interest rates, and a slightly increasing population will, unfortunately, eventually be offset by several prominent negatives. The "wild card" for my the housing market projections concerns what will happen to that part of our recent momentum fueled by the income brought back to this state by Rhode Islanders who recently secured jobs in other states. If they begin to follow those jobs, both our population and existing home sales momentum will diminish even further.

by Leonard Lardaro

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