Survey: Falling home prices may lead to less spending

Younger buyers believed most vulnerable to fluctuations in housing market

WASHINGTON -- A "sizeable" group of the country's most recent home buyers may embark on the economic ride of their relatively young lives, according to new research focusing on how they plan to deal with a possible slowdown in housing values.

Until recently, the housing gravy train has been hurtling along the tracks of appreciation. What happens if and when the engine that has driven the entire economy for the better part of four years hits the proverbial wall?

If prices simply stop rising, one in four homeowners say they'd have to rearrange their budgets, according to a recent poll of 2,261 homeowners in 13 areas of the country with the greatest concentration of new construction or the highest rates of appreciation.

However, should values fall by 10 percent, one in three would have to tighten their belts, and with a drop of 25 percent -- an amount that is not unprecedented -- one out of every two homeowners would be financially challenged.

"Homeowners in markets where prices drop are in for a hairy ride," said James Chung, president of Reach Advisors, the Belmont, Mass., market strategy and research firm that conducted the survey in September.

"Even if prices simply flatten, it is going to cause significant pain and have a large impact on the economy. Appreciation isn't bonus money for a lot of families; it's money that's already been spent."

Reach Advisors does a lot of work for developers and community builders, but conducted the survey independent of its clients.

"We have no agenda," Chung said. "Once or twice a year, independently of any specific client interests, we take on a topic we personally find intriguing."

What a subject it is: The long run of good fortune, and great fortune for many, is all some people talk about whether at a formal cocktail party or a neighborhood block party.

For many, according to Chung's "Moving Away From Easy Street" study, a house is not only a roof over their heads but also a high-performance investment vehicle, a home equity cash cow and the mainstay of their retirement planning, all rolled into one.

Chung isn't saying that the sky is falling, or that the end is even near. Rather, the researcher said he simply wanted to gain some insight into what consumers might do if the housing market turns, and what he discovered surprised him.

Nearly half the homeowners in the study reported they would cut back on their spending if prices drop even a little.

"A sizeable part of the population, certainly more than we expected, is betting that housing prices are going to continue to increase," he found. "So if prices don't keep gaining ground, many people will be forced to alter their spending habits, which is an issue that has major macroeconomic implications."

Also, just one in three families with adjustable rate mortgages have no plan in place for handling higher house payments if their loan rates should increase. That number may even be on the low side, since an additional 16 percent expect to refinance at favorable rates and 20 percent more plan to move before their rates rise.

Chung isn't an economist, but he knows mortgage rates are heading up, ever so slowly. He worries that rates, and therefore housing costs, may turn up so aggressively that these optimists won't be able to react fast enough to avoid a train wreck.

Just how badly folks are hurt depends on how deep housing prices drop, if they drop at all. Based on the results of his survey, Chung said the number of people who would be impacted by declining values "scales up dramatically" as prices drop, largely because too many have their heads in the sand and are not prepared for a downturn.

"Every major home builder and developer has a plan in case the market turns south, but this isn't the case for American homeowners," he said. "Some are not going to make it."

Hardest hit could be some of the Gen Xers. In particular, the ones who are 26- to 33-year-olds are twice as likely to believe the current rate of appreciation will allow them to trade up from their starter homes to bigger and better models.

In addition, those who hold ARMs are nearly twice as likely, 29 percent vs. 16 percent of other survey respondents, to expect to refinance into more favorable financing. Of course, those who hold ARMs often consider changing to a fixed-rate mortgage in the future and may consider that to be more favorables terms.

Research response shows Chung that "their optimism is tempered by a cold dose of reality." Two-thirds said they'd cut their budgets if housing values fell even the least tiny bit.

Some Gen Xers have stretched their finances the most to tap into easy appreciation and financing. They hold more inflation-adjusted housing debt than baby boomers did at the same age.

Boomers, on the other hand, can afford to live large because they have amassed extremely large amounts of home equity. So "the fortunate generation," as Chung calls them, has the least problem with a potential drop in home prices.

"They're in pretty good shape because they don't owe anything," the researcher said.

"They're the most pessimistic, but they can afford to be. They've owned their homes for nine years or longer and they have no mortgage."

Regionally, the survey found that when compared with other markets, owners in the Atlanta area are most likely to face financial problems if prices stop rising. This is something of a surprise because Atlanta is rarely mentioned as one of those places where house prices are out of whack with reality.

Chung said that with three decades of "spectacular growth" under their belts, these are the folks who are "most likely" to have stretched themselves financially.

Because of their state's extremely high housing costs, Californians are the least likely to hold more conventional, and safer, fixed-rate loans. So they, too, could be in for a big reality check if prices back down. Buyers in this state "are the most likely to be counting on real estate appreciation," Chung said. "If their outlook wasn't so darn sunny, California might be a rather gloomy place."

Owners in North Carolina are split in their views of the future. The state registered the highest percentages of folks believing prices will continue to grow on a steady basis as well as people thinking price drops are on the horizon. Arizonans, on the other hand, are the most confident, while people living in the Northeast and Florida are the most pessimistic.

Lew Sichelman has been covering real estate for more than 30 years. He is a regular contributor to numerous shelter magazines and housing and housing finance industry publications.