Housing's Roof Collapses

By John S. DeMott

Costs of homes are coming down, as those high interest rates kill sales

The U.S. housing industry, already creaking in the wind like an ill-maintained Victorian mansion, did not need the news out of Washington last week. The Federal Home Loan Bank Board reported that the nationwide mortgage interest rate rose to a blistering average 16.95% in early July, a record, and nearly double the rate of just five years ago. It is expected to surpass 17% this month. This means that a couple buying a $70,000 house, who have put down the standard 25% and financed the remaining $52,500 mortgage for 25 years, would have monthly principal and interest payments of $755. They would wind up putting out $244,000 for the dwelling, with $174,000 of that going for interest alone.

Largely because of the high cost of mortgage money, sales of new single-family homes dropped 17.2% from May to June. That depressed the annual sales rate of those homes to 408,000, the slowest pace since April 1980 when the economy was in a brief but sharp recession. In contrast, the best month ever for new dwellings was October 1978, when new homes were selling twice as fast: at an annual rate of 872,000.

The picture is almost as grim when it comes to housing starts, the point where men, materials and money combine to build a house. In June, starts were running at an annual level of slightly more than 1 million, less than half the record rate of 2.5 million set in January 1972. Further depressing the market is the growing inventory of unsold completed homes, enough for 9.3 months of sales at the current pace. This is second only to the record backlog of 12.4 months in April 1980. Sluggish starts have idled construction crews, slowed demand for everything from roofing nails, cement and lumber to sashes, sills and sand, and generally contributed to the slowdown in the U.S. economy.

The only modestly bright spot in the housing industry was the sale of existing homes, which rose by 6% in June to an annual rate of 2.6 million. The increase, though, reflected the vagaries of home financing rather than any strength in housing. With interest rates high and banks short of money to lend, the owner often has to offer the buyer a mortgage, if he hopes to sell. That has helped the turnover of older houses. Nonetheless, this part of the market is still 35% lower than its November 1978 peak of 4 million on an annual basis.

Summer is the traditional high point of the real estate year, as thousands of executives move their families to a new job in a new city. The people transferred this year are having trouble finding qualified buyers for their houses. Says veteran Real Estate Appraiser Joseph L. Donnelly in Washington, D.C.: "Buyers are few and far between. Sales volume is off drastically." In the Beverly Glen section of Los Angeles, nearly every third house has a FOR SALE sign out in front.

Median-priced homes are the part of the market hit hardest by the slump.

Says John Pfister, a real estate analyst at the Chicago Title and Trust Co.: "Luxury housing moves with the Dow Jones averages and has held up well. So has the lower end of the market. But the middle ranges show real weakness." Says one Manhattan broker: "The higher-priced apartments will sell at any time. When you're paying $500,000, you don't care about financing."

As a result of slow sales, house prices are now dipping in many parts of the country for the first time in years. Nationally, the median price for a single-family new home inched down $200 from May to June, to $71,600. California Developer Peter Landau has slashed the prices on his two-bedroom Countrylane Townhouses in the San Fernando Valley outside Los Angeles from $108,000 to $93,000.

Few housing experts believe that the sluggishness in prices will continue long enough to produce a drop in housing prices over the course of the entire year. That has not happened since the recession year of 1970, when the median price declined to $23,400 from $25,600 the previous year.

The real estate madness during the past few years was strongest in California. During 1977, prices of California houses jumped 20.1%, and then they rose another 19.1% in 1978. Like spiraling stock prices in the 1920s, few thought the rise would end. But now it is doing just that, and some people are scrambling to get out.

Los Angeles Publicist Philip Paladino, 45, paid $73,000 eight years ago for a house in Bel Air. Last month he told his wife: "Let's dump it. I think the market is going to crash."

Paladino listed the property for $595,000 but accepted $515,000 in cash, which he immediately put into short-term money-market investments.

A couple of years ago, new homes for sale in California were snatched up almost as soon as they became available. In Santa Monica today, the average house stands unsold for up to 90 days. Ronald Reagan's plush three-bedroom Pacific Palisades house went on the market in January at $1.9 million. Finally, eight months later, an Orange County developer is interested in buying at that price, but he requests that Reagan provide some of the financing through an owner-supplied mortgage. No agreement has yet been reached.

Most affected by the high interest and slow sales are the California homeowners who cashed in on the sharply rising value of their property in the 1970s by taking out second, third and even fourth mortgages. In one fairly typical case in San Jose, a $34,000 first mortgage was followed in quick succession by two others of $15,000 and $10,000, the latter a six-month one with an annual interest rate of 25%. The failure of the last mortgage triggered a foreclosure on the house, one of hundreds in California in recent months. The rate of delinquent home payments has also jumped in the past two months in the state. In Contra Costa County near San Francisco, the number of delinquent payment notices was 200 a month last year; now it is nearly 400 monthly.

"Creative financing," which was pioneered in California, has doubtless led to some of the problems. This type of loan legerdemain encourages the use of medium-term borrowing and schemes such as variable rate mortgages and shared appreciation between the bank and the buyer. But creative financing has become necessary for many would-be homeowners, contends Willard Sprague, an economist at San Francisco's Wells Fargo Bank. Says he: "Only about 10% of California households can afford to buy the median-priced home [$105,800 in California] with conventional financing."

Is housing dead? That same question was asked 15 years ago during a credit crunch when mortgage rates reached a then phenomenal 6.5% after hovering for years at around 5%. Even in today's market, experts are not about to dismiss the U.S. housing industry. High interest rates have made the market stagnant, but they have also created pent-up demand among the baby-boom generation, who are now in their 30s. New housing is currently being built at less than half the 2 million-a-year rate needed just to keep up with those potential buyers. Robert Sheehan, director of economic research for the National Association of Home Builders, believes that the 1980s could still be a very strong decade for housing. But that will occur only if mortgage rates begin to slip from their current record levels. -- By John S. DeMott.

Reported by Patricia Delaney/Chicago and Michael Moritz/San Francisco, with other U.S. bureaus

With reporting by Patricia Delaney/Chicago, Michael Moritz/San Francisco

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