The Search for Shelter

By John Greenwald

Prospects of rising interest rates create confusion in the housing market

Is American home buying about to rise through the roof, or will it collapse and crash through the floor? That question is vexing builders, bankers and home buyers this spring as the prime house-hunting season gets under way. Indeed, the U.S. housing market suddenly seems to be a mass of confusing and conflicting signs.

Last week the Government revealed that March housing starts had taken the sharpest drop (26.6%) since records began to be kept in 1959. That disclosure, which put new construction for the month at an annual rate of 1.6 million units, dashed hopes that a major housing boom might be at hand. Such a surge had seemed pos sible just a month ago on the strength of news that February home starts were at a 2.2 million annual pace, the briskest in eleven years.

More mixed economic signals appeared last week. One day after reporting that personal income rose a scant .5% in March, the Government announced that the gross national product grew by an astonishing 8.3% in the first quarter of 1984. That was far above the Commerce Department's 7.2% preliminary estimate, and stunningly higher than the 5%-to-6% forecast for growth that most private economists had made. The gain in the G.N.P. was due primarily to higher inventories, a continuation of vigorous consumer spending and a hefty boost in federal farm subsidies.

The stronger-than-expected growth again raised fears of higher interest rates. Concern about the cost of money has in fact been a major influence on the housing market lately. Many consumers are rushing to buy because they think mortgage rates are going up. "I knew higher interest rates were on the way," recalls Donald Brooke, 37, a Chicago chemical engineer who last month bought a $100,000 home. "Originally I was going to wait before making a commitment, but this seemed the time to buy before costs got too high."

Steeper interest rates could bring the entire housing industry to a halt. The cost of a conventional, fixed-rate mortgage has been edging up: such loans averaged about 13.85% in March, compared with 13.69% a month earlier. Each percentage-point boost in mortgage prices knocks about 2.5 million potential buyers out of the housing market. Above a rate of 14%, moreover, only about one family in six can qualify for a mortgage. Says Ken Kerin, vice president for economics and research of the National Association of Realtors: "Our greatest fear is another notch up in mortgage rates. If they go up another three-quarters of a percentage point, we could repeat the experience of 1981 and 1982 and end up with a housing crunch."

Construction companies also have been fretting about the outlook. An April survey of the National Association of Home Builders found that members fear that business will worsen in coming months. It was the first sign of pessimism in two years. "Change is in the wind," says Michael Sumichrast, chief economist for the organization of 40,000 builders.

Wall Street shares that wary view. "Many housing stocks have not looked good from a growth and investment standpoint," says Dean Witter Analyst Alan Wapnick. "They've really gotten hammered." For example, the share price of U.S. Home, the largest American homebuilder, is down more than 60% from its 52-week high of 20 3/4 last May. An important reason for the decline, says Wapnick, is the prospect of higher interest rates.

So far, though, many consumers have been able to duck some of the high cost of money by taking out adjustable-rate mortgages from builders and lenders. Such loans, which typically are made at 2 to 2.5 percentage points below the interest on fixed-rate mortgages and begin to rise after a year, now account for an estimated 60% of all home lending. Notes Robert Adelizzi, president of San Diego-based Home Federal Savings & Loan: "As many as 200,000 U.S. families last year were able to get into housing that they would not have been able to afford without adjustable-rate mortgages."

Among those who have taken advantage of the reduced initial borrowing costs are Michael and Cheryl Petryni, who recently bought a $161,000, three-bedroom suburban Los Angeles home. Their loan carries a first-year interest rate of 10 1/4% and has a cap that will keep the rate from rising above 15 1/4%. Says Michael Petryni, 36, a screenwriter: "I studied the adjustable mortgages at seven different lending institutions, and after a while they all started to sound the same."

Critics charge that adjustable loans could lead to a wave of defaults. While some borrowers may have little trouble keeping up with the rising interest costs, others could find their budgets severely strained. "Many of these mortgages seem to be ticking time bombs," says Irwin Kellner, chief economist for Manufacturers Hanover. "They could start exploding in the face of homeowners and lenders alike."

Nevertheless, increasing numbers of buyers seem willing to take the risk. The children born during the postwar baby boom are establishing families, and they want shelter. Some 40 million Americans are now 25 to 34, up 70% from 1947. Young first-time buyers accounted for nearly 40% of last year's housing market, compared with just 13.5% in 1981. The newcomers helped push the 1983 housing-start rate to 1.7 million homes, compared with an anemic 1.06 million level in 1982, and thus can claim some credit for last year's vigorous homebuilding turnaround.

Young buyers find, however, that they frequently must settle for tight accommodations. With the median cost of a new home now $79,500, up 7.7% from a year ago, an affordable starter house may turn out to be little larger than a roomy cabin. In Hudson, N.H., eager buyers have been plunking down $60,000 for two-bedroom town-house units that Builder John Stabile has packed into 1,050 sq. ft., or about half the size of a singles tennis court. On the outskirts of Southern California's San Fernando Valley, $90,000 can buy a Kaufman & Broad two-bedroom, 1,000-sq.-ft. single-family home. For the Los Angeles area, that price is cheap.

To make small houses feel larger, builders and architects have been using some design legerdemain. They are frequently eliminating entry halls and fireplaces, for example, and making liberal use of vaulted ceilings, skylights and floor-to-ceiling mirrors, which give a sense of space. Some are adding such details as sculptured wall niches and extra display space for plants or baskets.

Housing styles are undergoing change to meet the desires of the new first-time buyers. Many builders are turning from town houses and condominiums to single-family homes. "The marketplace is asking for detached houses," says Santa Barbara Architect Barry Berkus, who has designed units throughout the U.S. "In some areas they are as narrow as 25 feet, but families want privacy and outdoor space." To provide the space yet keep total costs down, builders are offering two-story Victorian-type models that take less land than the traditional one-story ranch and split-level homes and have the added advantage of being cheaper to heat.

But not all new homes are elegantly styled boxes. Chatham Homes in Atlanta sells custom-designed units that range from $150,000 to $600,000 for a six-bed-room home with a swimming pool and a three-car garage. Says President David Chatham: "The luxury market has been extremely strong."

Housing watchers have been noticing another important trend among many of today's home buyers. Instead of trading up to larger homes as often as they switch cars, consumers are staying put. Even in California, where feverishly rising prices made homes a lucrative investment during the late 1970s, purchasers are now thinking more about settling down. Says Stephen Shapiro of Stan Herman Realty in Beverly Hills: "We're back to an emotional buyer, someone who really wants to live in the house."

To be sure, housing demand varies from region to region, and even between cities in the same state. In Houston, which is suffering from the downturn in the energy business, thousands of homes remain vacant and unsold. "Houston is the No. 1 loser city in the U.S.," says Kenneth Rosen, chairman of the Center for Real Estate and Urban Economics at the University of California at Berkeley. Booming Dallas, on the other hand, has been a refuge for Houston construction firms. Notes Phil Jobe, president of the Dallas Home and Apartment Builders Association: "Our membership has gone up by more than 300 firms since November. People come up from Houston, look at the strength of our market, and open up an office."

For now, at least, builders and other experts expect 1984 housing starts to be comparable to the 1.7 million rate recorded last year. That would be strong by recent standards but far below the record of 2.4 million reached in 1972. "We have seen as much of a housing boom as we're going to get," says Kerin of the National Association of Realtors. Concurs Malcolm Prine, chairman of Pittsburgh-based Ryan Homes, a major U.S. builder: "We'll look back on 1984 as roughly equivalent to 1983. It will be a platform year, either leading to a prosperous period for the next five years or declining into a relatively severe recession."

The chief obstacle to prosperity, Prine and others agree, is the federal deficit, which is expected to come to about $180 billion this year. The heavy federal borrowing needed to finance that deficit is certain to keep pressure on interest rates and the home-buying market. A meaningful reduction in the deficit, by contrast, could lay the foundation for a genuine housing boom.

--By John Greenwald.

Reported by Gisela Bolte/Washington and Laura Meyers/Los Angeles

With reporting by Gisela Bolte, Laura Meyers