29 Apr 2013

Nicolas Retsinas Diagnoses the Recovering U.S. Housing Market


The U.S. housing market is no longer a basket case. Data from the S&P/Case-Shiller Home Price Indices show that average home prices in an assortment of American cities have been on the upswing, increasing by almost 7 percent across the country in 2012. Recent reports that sales of new single-family homes rose in March are proof points that “the housing market recovery remains on track.”

Nicolas P. Retsinas is a Senior Lecturer in Real Estate at Harvard Business School, Director Emeritus of Harvard University’s Joint Center for Housing Studies, and former Federal Housing Commissioner.

Nicolas Retsinas

HBS: What factors have been contributing to the housing recovery?

Retsinas: Several factors are generating a tailwind for the recovery, although it varies from market to market. In large measure it has to do with improvement in the economy as a whole, household formation (that is, children moving out of their parents’ home in an improving job market), and abnormally low interest rates. Supply and demand, of course, always have an impact, with an additional element in select markets such as Phoenix, Las Vegas, and southern California, where prices fell by half or more after the downturn and where financial firms like The Blackstone Group have been buying large numbers of single-family detached homes that they then rent, hoping to eventually sell them as an exit to their investment. This kind of institutional buying, however, is not happening as much in markets like Boston and New York, where prices did not fall so far and where there are not large numbers of foreclosed single-family homes. But all things considered, there is evidence that we may have turned the corner.

How successful have been the Obama Administration’s efforts to loosen credit for individual homebuyers?

It is, of course, much more difficult for individuals and families today to obtain credit than it was at the height of the housing boom. Now you need — surprise, surprise — documentation. Now you need to be employed. Now you need to have a down payment. All those things were absent during the housing boom. So we have tightened credit dramatically, which has contributed to the reality that this recovery has not been as robust as those in the past.

There are some mixed messages coming out of Washington as well. President Obama wants to accelerate the housing recovery, because it is such an important part of our economy and would help with the overall economic recovery. However, in the mortgage market today, ninety-five percent of all mortgage loans are guaranteed, insured, or securitized by the US government, which is obsessed with not losing money on these guarantees. And the way the government does not lose money is by making the requirements even more stringent for borrowers. So on the one hand, the political policy is to extend credit; on the other, the government-owned enterprises (Fannie and Freddie Mac) are trying to narrow the credit box because they so afraid of incurring a loss.

Tax reform is high on the public agenda these days. What’s your take on the viability of the mortgage interest deduction in the midst of calls to increase revenues and decrease loopholes?

First, let us put the mortgage interest deduction in historical context. It came about when the federal income tax became permanent in 1913. At that time, everything was deductible, including mortgage interest, a deduction that came to be accepted as a means to helping people achieve the “American dream” of owning a home. In 1986, however, that concept began to run into some opposition, when President Reagan put forth some proposals to simplify the tax code — eliminate deductions and just submit your income on the back of a postcard.

All this was met with a barrage of criticisms, primarily from two groups: charities concerned that it would undermine giving, and realtors, home builders, and mortgage bankers, who were afraid that removing the mortgage interest deduction would lessen the incentive for buying a home. Bottom line, the deduction remained, but with one change. Instead of being unlimited, it was capped at a million dollars. As we look back at what happened with the housing market implosion, I think it’s fair to say we over-encouraged and over-supported home ownership. A tax subsidy like the mortgage interest deduction, which reduces the amount of money available to the federal government by $100 billion a year, is understandably at risk today because of our concern with deficit reduction. To put this huge number in context, the total budget of the U.S. Department of Housing and Urban Development, the primary agency for dealing with affordable housing in this country, is about $35 billion.

Realtors say the sky will fall if we end the mortgage interest deduction — that it would adversely affect the market and undermine home prices over time, but the evidence says that if one did this slowly, maybe lowered the cap, and changed it in a way that would be more supportive of first-time home buyers and those below a certain income, people would adjust. The mortgage interest deduction is a sacred cow, but I think that in an era when everybody is trying to look at the budget, there is some question as to whether the wealthy should continue to have a bite of that cow.

Do you think more people these days are content to rent?

There have been a variety of surveys on the rent vs. own question. A recent MacArthur Foundation survey said that more people regard renting as an acceptable option. But I saw another survey recently that concluded that two-thirds of American families preferred to own. I edited a book 15 years ago, Low income Home Ownership: Examining the Unexamined Goal, that supports the second finding. I found that the desire to own a home was part of the psyche of just about everyone I studied, no matter where they lived. The only exception was a nomadic tribe in North Africa that noted that “homes were graveyards for the living.” But every other culture and country I looked at had a least nominal support for owning a home for the sake of things like family stability and the opportunity to pass one something of value to one’s children.

With tightened credit in the mortgage market, renting has now become a desirable option, and for many young families, it is the only option, since they don’t have the wherewithal for a down payment. But as rents go up in the face of increased demand, the difference between renting and owning will decrease. When that equilibrium happens, I suspect there will be a return to ownership as the preferred long-term option. Again, the question is: Can we design a system that will extend credit to young first-time homebuyers while not incurring too much risk. That is our challenge.

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