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Housing Outlook, 2017: Home Prices Keep Climbing

Pat Mertz Esswein, Associate Editor, Kiplinger's Personal Finance
But as mortgage rates ratchet up, homes will be less affordable, tamping down sales and home-price growth in many cities.

Home prices rose at a nice clip in 2016 as buyers, encouraged by job growth and exceptionally low mortgage rates, competed for slim pickings. Prices increased 5.8% nationally, compared with 4% in 2015, according to Clear Capital, a provider of real estate data and analysis. But with home prices out of reach for many first-time buyers, a limited supply of homes for sale and mortgage credit still tight, Kiplinger forecasts that price increases in 2017 will revert to a 4% pace--the historical U.S. average.

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Home values rose in 253 of 276 cities tracked by Clear Capital, going up by double digits in about one-fifth of them. The cities with the biggest gains were buoyed by vibrant local economies, where rising population and job growth fueled demand. They include Deltona, Fla. (with a gain of 14.7%), Austin, Texas (14.5%), Salt Lake City (12.3%), Seattle (11.4%) and Portland, Ore. (11.4%). But many homeowners have been left behind in the latest price run-up. Average prices remain nearly 12% below the peak they hit just before the housing bust a decade ago. And home values fell in a couple of dozen metro areas--mainly in parts of the Northeast, Mid Atlantic, and industrial Midwest and South. The price drops occurred mostly in smaller cities with lackluster economies, such as Watertown, N.Y. (-7.2%), South Bend, Ind. (-7.6%), Atlantic City, N.J. (-9.9%), and Baton Rouge, La. (-3.3%), where the economy took a hit because of declining oil prices.

During the last boom, "everyone did well," says Alex Villacorta, vice president of research and analytics at Clear Capital. "In the downturn, everyone did badly. As the recovery began, everyone got a bump-up. Now, there are winners and losers."

Housing Market Headwinds

Existing home sales in 2016 rose by about 1%, to 5.5 million--and that is the highest level since 2006, says the National Association of Realtors. The NAR doesn't expect sales to increase by much at all in 2017. Nationwide, the number of homes for sale fell throughout 2016, and the year ended with 3.6 months' supply (the time it would take to sell the current number of homes on the market at the current pace). The NAR says that six to seven months' supply is considered balanced between buyers and sellers. Because half of all homes for sale are in the premium category, luxury buyers, buoyed by their stock market portfolios, will have little difficulty. But entry-level and trade-up buyers face a housing shortage.

Why is inventory so limited? A lot of homeowners who might trade up still haven't regained enough equity to cover the cost of selling their current home and making a down payment on the next one. More than 11.5 million homeowners are still underwater. That means they've just broken even or still owe more on their mortgage than they could sell their home for now (see The Outlook for Mortgages, 2017). And because most of those homeowners have entry-level homes, the inventory for first-time buyers remains paltry.

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Even homeowners with enough equity to sell are delaying because they fear they won't find (or haven't found) something they want to buy. Some are balking at giving up the low mortgage rate they nabbed when they bought or refinanced previously. Rather, they've been borrowing against their equity to remodel. In 2015, home-equity lending increased by nearly one-third from 2014, and the average size of a home-equity line of credit was $118,694, according to CoreLogic, a financial data and analytics company. Still others don't want to make a move until they've paid down student-loan debt, says the NAR.

What's more, homes have become less affordable since 2012. The relative affordability of homes nationally peaked then, but tepid income growth has failed to keep up with rapidly rising home prices (and rents), says Daren Blomquist, a senior vice president of Attom Data Solutions, which analyzes property data. With additional interest-rate hikes expected in 2017, homes will become even less affordable, tamping down sales and home-price growth in many cities. In the most expensive markets, even a small increase in rates can have a big impact on affordability, especially for first-time home buyers struggling to come up with a down payment.

Although rent increases have begun to slow, investors who snatched up bargain properties during the downturn and converted them to rentals show no sign yet of selling them and cashing out. They continue to enjoy low vacancy rates and steady income.

And although builders started construction on more than 1.2 million homes in 2016, the highest level since 2007, they're still just two-thirds of the way back to their long-term average--and they haven't been building many starter homes, says Ralph McLaughlin, chief economist at Trulia, an online real estate marketplace. Builders continue to contend with a shortage of skilled labor and buildable lots.

The Trump Effect

The unevenness of the economic and housing-market recovery across the U.S. played a big role in the outcome of the presidential election. Voters living in cities that have experienced strong growth in jobs and home prices--many of them on the coasts--voted in large numbers for Hillary Clinton, whereas those living in cities that have been slow to recover largely supported Donald Trump.

McLaughlin says post-election polls commissioned by Trulia show that voters in "red" cities switched from feeling very pessimistic to feeling very optimistic about their housing markets, with the expectation that President Trump would boost business interests, bring jobs back to their areas and put more money in their pockets. But McLaughlin worries that some of the president's policies could eventually impede economic growth and hurt housing sales.

KIPLINGER'S ECONOMIC OUTLOOK: Housing: A Seller's Market in Many Cities

To promote continued recovery of the housing market, McLaughlin says, the new administration needs to emphasize policies that will increase the supply of homes on the "Costly Coasts" and jobs in the "Bargain Belt," as McLaughlin calls them. He worries that the president may do just the reverse, overemphasizing policies that increase demand and underemphasizing those that increase supply.

For example, promoting credit availability and reducing tax rates could boost demand. However, demand could be undercut if President Trump and Congress follow through on proposals to raise the standard deduction and eliminate the write-off for property taxes. With those changes, many people wouldn't bother itemizing deductions, reducing the appeal of deductions for mortgage interest and property taxes.

On the supply side, the shortage of new homes could grow worse with the Trump administration's immigration policies because builders will have a harder time finding affordable labor. McLaughlin says it would help if Trump created incentives to encourage investors to sell homes they bought during the foreclosure crisis, many of which are starter homes. Such incentives could include a reduction in capital-gains taxes for homes sold by investors to owners who live in the home, an increase in tax rates on rental income, or both.

See Also: 7 Features That Will Sell Your Home Faster

A Challenge for Buyers

Millions of homeowners have felt the wealth effect of rising home prices. Some have parlayed rising equity into refis with lower mortgage rates, and some have taken the opportunity to borrow against their home to remodel or pay off higher-rate debt. Others can now sell their home at a price high enough to pay off their mortgage and trade up to a new home. Still others are using the extra equity to qualify for a reverse mortgage to supplement retirement income.

If you plan to buy this year, be ready to stretch your budget or compromise on the size and location of a home, says Lawrence Yun, chief economist at the NAR. Find out how much house you can really afford by getting prequalified by a lender. That will limit your search and reassure sellers that you can close the deal. The more information the lender requires beyond just a credit score, the more reliable the preapproval. You can still shop later for the best rate and cheapest closing costs.

If you make an offer on a home within the first few days it's on the market and your agent can show you that recent comparable sales support the asking price, bid at or close to that price. If the sellers' agent reveals that you're competing with other buyers, you may have to bid more than the asking price. You can require sellers to respond to your offer within, say, 24 hours, so they can't hold out for better offers, says Dawn Rae, an exclusive buyer's agent in St. Petersburg, Fla. Also, to make the most attractive offer, include the largest down payment and earnest-money deposit you can muster, usually 1% to 3% of the agreed-upon purchase price.

Most buyers include contingencies for financing and a home inspection, but your offer will be much more attractive if you're able to make compromises. That's what Mary Chris and Wayne Bailey did to snag a house that got away the first time. In 2014, the couple started to plan their move from Newton, Mass., to Florida after they retired. They considered buying a 1,820-square-foot home in St. Pete Beach, with four bedrooms, two bathrooms and a pool, and an easy walk to the Gulf of Mexico. It was listed for $350,000, but they weren't convinced that it was right for them, and it sold to someone else for $348,000. By the fall of 2016, the same house was back on the market, listed for $385,000. The Baileys decided to go for it. They knew sales had picked up and the bargains were gone, and they fretted that they wouldn't find anything that was as good a fit. "If we dithered, the prices would just continue to escalate," says Mary Chris. "We decided to make a strong offer and get it done."

See Also: 8 Things Home Buyers Will Hate About Your House

The Baileys didn't make their offer contingent on the sale of their home in Massachusetts. And although they asked for a home inspection, they agreed with the seller not to renegotiate the purchase price afterward. The seller accepted their offer immediately. The Baileys listed their home in Newton for sale in the summer of 2016. They rejected several offers for less than their asking price but accepted one for about 12.5% less in December.

The couple are pleased with their purchase in Florida. They love the location, and they plan to fix up the house. "It will be quite charming," says Mary Chris.

Other ways to make your offer more appealing to sellers: Include a shorter inspection period, say 10 days instead of 15, so the sellers will know as soon as possible whether there are any issues they must address. Or, depending on your state's real estate law, you may agree to an "as is" contract; in Florida, that means you have the right to an inspection and can cancel the contract within the inspection period if it turns up unacceptable problems.

If you're on the sell side and you live in a city with rising home prices, few homes for sale and a rapid turnover, you have the advantage over buyers--in theory. But price a home too high and it's likely to sell more slowly and ultimately for less. Plus, if the sale price doesn't match the appraised value required to get a mortgage, buyers will balk about forking over the cash to cover the difference.

TAKE OUR QUIZ: How Smart of a Home Seller Are You?

Copyright 2017 The Kiplinger Washington Editors