KENNETH HARNEY: Middle America poised for real estate gains

June 4, 2006 republished from the Detroit Free Press

WASHINGTON -- Could the real estate action be shifting to the heartland -- the vast swath of Middle America that never really was touched by the hyperinflationary housing boom?

That's what a new statistical analysis of housing price cycles in 100 major metropolitan areas suggests could be over the horizon. Its author, Christopher L. Cagan, director of research and analytics for First American Real Estate Solutions, examined historical housing price movements and concluded that metropolitan real estate markets can be placed into three distinct categories:

· Linear markets, where booms and busts virtually never occur. Prices plod along, year in and year out, gaining modestly. Local changes in economic growth may nudge prices up or down, but the moves rarely are dramatic.
Much of the middle-American heartland fits in this category. Examples include Columbus, Ohio; Indianapolis; Houston; San Antonio; Memphis, Tenn.; Atlanta; Cincinnati; Des Moines, Iowa, and Louisville, Ky

· Cyclic markets. These are the shooting stars of housing booms. Generally they are located along the East and West coasts, where household incomes are higher and land for new construction is in short supply. They include most of California from the San Francisco Bay area south, much of Florida, metropolitan Washington, D.C., and Baltimore, New York and much of New England.
When conditions are ripe -- as they have been recently -- annual housing gains in these areas can exceed 20% to 30% at the cyclical peak. Typically, however, the local booms burn themselves out by pushing prices to unaffordable levels.
Some cyclic markets experience jolting corrections that knock prices down by 15% to 25%, as occurred in southern California in the early 1990s following a multiyear boom. Other markets' corrections may be less severe; appreciation rates dwindle to the low single digits or go flat for a while, then begin the upward cycle again.

· Hybrid markets. These are areas that have linear, slow-growth characteristics for periods, followed by periods of moderate cyclic-style appreciation. They never boom quite like Florida or California, but they also don't correct like the more volatile markets. Cagan includes Detroit, Chicago, Seattle, Minneapolis-St. Paul and Phoenix in this category.
In Cagan's analysis, the rest of the decade will offer significant investment opportunities for linear real estate markets -- at least those with expanding employment bases and moderate housing prices.

Most of the cyclic markets "are at, or have already passed, the peak" of their cycles, he says. Absent unseen economic shocks, the shooting-star markets aren't likely to crash or burn. They're just not likely to see anywhere near the price growth they've gotten used to in recent years.
On the other hand, according to Cagan, linear markets -- especially in Texas, Colorado and the energy-belt areas of the Southwest -- appear to be poised for above-average price increases and home building.

"Texas is the real beneficiary" of the energy crunch squeezing the rest of the country, said Cagan. Not only is job growth strong, but housing prices are relatively moderate.

"Look at the median home prices in Dallas and Houston. Property there looks cheap" from the perspective of California or Washington, D.C., or New York, said Cagan, whose research firm is headquartered in Santa Ana, Calif., one of the flashiest markets.

Equally important: The major heartland markets are nowhere near their price growth limits, based on Cagan's examination of household incomes. Beyond that, in Cagan's view, many of the heartland metropolitan areas "are basically very nice places to live and work. They've got good schools, lots of parks and open space, plus you can afford to buy a home with a median income."

Those qualities could accelerate population movements: Families and companies in high-cost, high-tax cyclic markets might consider relocating to more affordable interior areas of the country with solid local economies and pleasant living environments. There is anecdotal evidence that some of that is already under way.

Cagan believes federal tax policies could support the trend as well. He envisions homeowners in equity-fattened but high-cost cyclic markets cashing in their appreciation gains and putting their $500,000 tax-free exclusions into real estate in more moderately priced markets.

Bottom line here: Understand where you are in the market cycle and adapt. Slower appreciation shouldn't hurt cyclic markets; to the contrary, it should eventually allow incomes to catch up to home prices. Improved affordability will help get the new cycle rolling again.

On the other hand, if you're in a linear or a hybrid market where the local economy is adding jobs and population, who knows? You might be in line for above average price gains over the coming years.
Make the most of it.

KENNETH HARNEY, based in Washington, writes on national housing issues. His e-mail address is kharney@winstarmail.com.