DAVID LEREAH
‘A different scenario’

Buyers stretching their credit and relying on interest-only and other nontraditional loans to purchase a home could be one of the biggest risks in the real estate market, according to a housing economist who spoke at a recent Realtors conference.

The rising popularity of those so-called exotic loan products, along with a significant spike in mortgage interest rates, could spell trouble for the housing industry, according to David Lereah, chief economist for the National Association of Realtors.

But Lereah, as well as Federal Reserve Bank of Boston President Cathy E. Minehan, said job growth, a strong economy and population trends are likely to prop up the housing markets in New England and nationwide in the coming decade.

“The [economic] fundamentals in your market are still good. Are they great? No,” said Lereah, who along with Minehan spoke last Monday at the New England Realtors Conference in Boston.

Both economists were optimistic in their housing forecasts, dispelling any notion that the regional and national housing markets would experience a repeat of the market crash of the late 1980s and early 1990s.

Home sales likely will fall this year and home prices will rise at a more moderate pace both regionally and nationally, according to the economists.

NAR projects that nationwide home sales will decline by 6 percent this year, following record-setting sales in 2005, and that home prices will increase by 6 percent, compared to 12.5 percent last year. Sales will pick up again in 2007 to a more “sustainable pace,” after five consecutive years of record-breaking sales, said Lereah.

“2006 is the year to give back. We’re going to give back 6 to 7 percent,” he said. “We can’t sustain record-breaking sales every year.”

Despite the predominantly bright outlook, Lereah said there are clear signs that the market is “tiring,” including a drop-off in home sales, declining mortgage applications and rising inventories of unsold homes.

The Boston area currently has an 8.4-months’ supply of for-sale homes, compared to just over a five-months’ supply nationwide. The Boston region’s supply needs to be monitored, said Lereah, but he noted that Realtors should not fear a market crash like the one experienced in the late ’80s and early ’90s when the Bay State was in the throes of a sharp recession, interest rates were much higher and the Boston region had a 16-months’ supply of unsold homes.

“You’re not going to get there,” said Lereah, noting that job creation is starting to improve and interest rates are much lower than they were back then. “It’s a different scenario.”

During the last downturn, Boston had the “perfect storm” scenario that led to the housing “bubble bursting,” said Lereah, who compared the latest real estate boom to a blown-up balloon that is slowly deflating.

Still, the good news was tempered by the fact that New England has been trailing the rest of the country in job and population growth – key ingredients in the future performance of the real estate market, according to Lereah.

Job growth is starting to pick up in the region, with Connecticut and Vermont leading in job creation.

In Massachusetts, population fell by 236,000 in the last five years, and job growth was less than 1 percent in the last 12 months compared to about 1.5 percent nationwide, according to information Lereah presented last Monday.

The Bay State, along with California, New York, New Jersey and Illinois, were among the states with the largest population decline from 2000 to 2005, according to the U.S. Census Bureau.

Some Are ‘Confused’
David Wluka, president of the Massachusetts Association of Realtors, said Lereah’s presentation highlighted the need to expand industry and attract more business to Massachusetts, particularly since the state’s population has been slipping. But Wluka said a key challenge continues to be the limited supply of affordable housing in the Bay State.

New England’s employment levels at year-end in 2005 were slightly above the same period in 2004, according to Minehan. Massachusetts, which accounts for about half of the region’s jobs, was particularly hard-hit because of the slowdown in the high-tech sector in the late ’90s. “This state has seen slower employment and income growth than the rest of the country since 2001,” said Minehan.

As for the residential real estate market, Minehan said so far the data have not been clear on how much prices will fall in Massachusetts and the rest of New England.

“Is New England likely to feel the sting of cooling residential housing in a more significant way than the rest of the country? To be sure, home prices in New England are higher than most of the rest of the country, and the pace of appreciation here has been greater, at least until the last couple of years when it flattened out,” she said. “However, unlike the late ’80s, residential construction has not boomed, and there has been little speculative building.”

Both Minehan and Lereah also discussed how certain mortgage products, such as interest-only loans and adjustable-rate mortgages, are causing alarm in the industry. A third of all loans last year were adjustable-rate mortgages and more than 20 percent were interest-only, according to Lereah.

“Many are worried that the combination of these new mortgage instruments and borrowers who may be both highly leveraged and low- to moderate-income could result in real problems as interest rates escalate in conjunction with softening prices,” said Minehan. “There is no doubt that some potential exists for consumer hardship, at least in some types of consumers. At present, both national and regional bank credit quality and foreclosures remain at historically very low levels, though we’ve seen a very recent slight deterioration.”

Minehan acknowledged she was “concerned” about how some consumers will be affected by mortgages that become too costly and the implications for lenders and markets.

“At this point, I don’t view this as likely to be a major issue to the overall New England economy,” she said. “My sense is that Massachusetts and New England will experience some sustained cooling in real estate markets and some flattening of prices, but this trend is not likely to affect the region overall very negatively, and likely not more than the nation as a whole.”

Peter P. Casey, owner of Prudential Wilmot Whitney Real Estate in Weston, said he tells buyers – particularly first-time buyers and buyers who are trying to “move up” – to talk to a financial advisor before “engaging in that type of loan.”

“Once rates start rising, these folks will be caught by surprise,” said Casey.

At a time when the market is slumping, Realtors were buoyed by predictions that home prices would not fall, although Lereah said that some local markets could experience declines.

“Part of what’s hurting sales is the fear that some consumers have of the bubble bursting,” said Casey. “People need to understand what David [Lereah] is talking about.”

Wluka echoed those remarks, saying, “We have a large population of buyers and sellers who are confused. What is clear is that waiting the market out is not going to make a difference because interest rates can change and supply changes.”