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Are homebuyers too optimistic about rising prices?

Buyers are looking to buy housing again. And according to the California Association of Realtors, they expect prices to rise.
Buyers are looking to buy housing again. And according to the California Association of Realtors, they expect prices to rise.

It looks like the pendulum has swung back to the optimistic side for California home buyers. The California Association of Realtors released a study Tuesday showing that buyers are increasingly confident prices will go up in the future.

Which raises an obvious question: Are buyers in the state being too optimistic about rising prices, after being excessively pessimistic about prices falling in the aftermath of the housing bust? When the pendulum swings back, it often swings too far.

About 25 percent of the 800 home buyers surveyed by the trade organization think prices will be higher next year. That’s more than a threefold increase over what buyers said in 2009, in the depths of the housing crisis.

But that pales by comparison with the five-year and 10-year outlook. For those periods, home buyers expect 41 and 73 percent price increases, respectively. Clearly, there's a high probability that prices will be higher a decade from now than they are today. There's a little thing called inflation, after all, which typically runs at about 2-3 percent per year and, absent big upticks in home prices, provides the steady, reliable asset appreciation that homeowners buying for the long term are looking for. They don't call real estate a hedge against inflation for nothing. 

However, other factors affect the housing market, especially in California. As I've written, we're in the midst of a price bubble in Southern California, and even the CAR's own Chief Economist, Leslie Appleton-Young, has said that she's never seen a market like the one we're dealing with now. Betting on rising prices in the short term is risky. Very risky. The market isn't "normal" and could take some time to relocate its fundamentals.

A big factor that prospective homebuyers need to consider, for example, is the presence of investors — well-capitalized private equity funds, in some cases — in the California market. All-cash operators can make it more difficult for buyers seeking mortgages to compete, which then compels everyday buyers to bid prices up as they duke it out to buy the homes that are left.

So an optimistic five-year outlook should probably be tempered with an understanding that homebuyers could, depending on where they live in California, see some brief prices drops, once more housing inventory comes to market and various supply-demand imbalances smooth out.

For the moment, however, prices are rising. But tapping into those rising prices isn’t easy. Hopeful buyers  say it’s tough to get a mortgage. But if and when they do, more than 90 percent are going for fixed-rate loans at a time when interest rates are at historic lows.

And there's a 10,000 ton elephant in the room. Or just outside the room. Or maybe hanging around outside the U.S. Capitol, preparing to stomp its feet and make some very loud and angry trumpeting noises. Because despite the optimism about prices, there’s concern the mortgage-interest deduction — long considered completely sacrosanct, beyond the sensible reach of even the most deficit-hawkish lawmakers — may be under review by Congress, as part of the ongoing debate about the nation's burdened balance sheet.

Understandably, the CAR said that across all income ranges and age groups, the deduction is extremely important” and that if it went away, that would “price out” a lot of home buyers. The CAR is deeply invested in people continuing to buy houses, so you can see why it would highlight this aspect of the study.

Still, the study shows that the deduction is universally beloved, by homebuyers of modest as well as considerable means, and by buyers young and old. 

Makes sense. The deduction represents a huge subsidy that the federal government provides to homeowners, in the interest of having them "go long" on housing. The theory is that this makes for better neighborhoods — more stable due to greater investment — and provides home buyers with an incentive to leave the ranks of renters. Of course, it also helps the banks make more loans, by enabling borrowers, and particularly high-income buyers, to effectively discount those loans.

If you're looking for a absolutely huge upcoming fight in Washington D.C. — and one that will dramatically affect one of California's most important markets — look no further than the mortgage-tax deduction debate.

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