2006 Real Estate Market Forecast

“The real estate boom is showing signs of tiring, but because the fundamentals in our economy are so strong, what we’re calling a slowdown is really a stellar market by any definition,” said David Lereah, chief economist for the National Association of Realtors®.

Statistics gathered from Realtors® nationwide show that home sales in 2005 reached record levels. Commercial real estate activity also was robust.

For 2006, NAR is forecasting existing-home sales, including condos and cooperatives, of 6.86 million units, down 3.5 percent from the estimated all-time record of 7.11 million in 2005 and the second highest ever. New-home sales are expected to reach 1.24 million, down 4.6 percent from a record 1.3 million in 2005.

NAR is forecasting the commercial real estate business to perform similarly well, thanks in large part to resurging business spending that’s expected to offset cooling spending by consumers. After years of retrenching after the tech bust, companies are plowing a good chunk of their profits back into their businesses, driving demand in industrial markets, particularly those riding the wave in Asian and Central American trading.

“Industrial strength is one of the commercial stories for 2006,” said Kenneth Riggs, Jr., chief executive officer of Real Estate Research Corp. in Chicago.

The rise in business spending comes at a crucial time because consumers are showing signs of spending fatigue. Household debt loads remain high, and many households have already tapped the equity in their homes for extra cash. Consumers remain concerned about the economy, even though job growth has continued to pick up momentum the last two years, and incomes have been rising slightly.

The Consumer Confidence Index dropped to 85 in September, as measured by the Conference Board, a private economic research firm. The CCI had been about 100 in mid-2005. A number below 100 indicates weak consumer confidence. Although the indicator is expected to return to the 100-point mark before the end of 2006, it will likely stay below the 105 level that was typical in much of 2004 and early 2005.

Strong fundamentals

Despite sagging consumer confidence, economic fundamentals remain good. Continuing strong population growth (fueled in part by immigration and new household formation by boomer children) has been keeping housing demand at peak levels. Housing inventories, meanwhile, have remained out of balance with demand, even though inventories have been climbing. On a national basis, inventories were at a 4.7-month supply, up from a 3.8-month supply at the beginning of 2005, but still below the five- to six-month supply that is associated with balanced market conditions.

As the housing shortage eases, price appreciation will soften as supply moves into better balance with demand. NAR is forecasting national median price appreciation of 5.3 percent in 2006, down from 12.4 percent in 2005.

Expect price appreciation in the foothills area and NW Oregon to also soften this year, but to remain above the median appreciation rate for the nation.

Rising interest rates should also start to slow appreciation and the rate of sales. NAR expects interest on a 30-year, fixed-rate mortgage to average 6.5 percent in 2006, about one percentage point higher than in 2003 and 2004, but not much above the roughly 5.9-percent average of 2005.

Experts say easing price appreciation is not expected to help first-time home buyers, however, because of the continued increase in mortgage interest rates. This will be especially true in high-price states like California, New York and Florida.

“Housing affordability will continue to be a very tough problem for California,” said Leslie Appleton-Young, chief economist for the California Association of Realtors®.

Economists say that the most robust sales activity will be toward the lower end of the price spectrum in 2006. Sales on million-dollar homes have already started slowing, but homes that list near the local median price should be snapped up quickly.

“Anything affordably priced will continue to sell well,” said Frank Nothaft, chief economist for Freddie Mac.

Investment fuels commercial sector

Strong balance sheets for most U.S. companies will be a driving force in the strength of the commercial real estate market, analysts say. Fixed business investment, which had plunged more than 10 percent annually after the tech bust, has been steadily climbing back. In early 2005, investment was growing at a 10-percent rate, federal data show. Huge public and private investment for rebuilding after the hurricanes should add to the trend.

With unemployment expected to shrink, and core inflation remaining relatively low, the stage is set for more strong capital inflows into commercial real estate, Riggs said.

The number of sales transactions in all commercial sectors was up in 2005, and that trend is forecasted to continue.

Sales activity on industrial buildings was up 83 percent in the third quarter of last year and leading all other sectors. Industrial will continue to be an investor favorite in 2006. Massive trade with countries abroad, particularly in Asia, is a root of the sector’s strength. “Economies with strong port and distribution bases will do well,” said Riggs.

Good bets are southern California, the main hub for trade with China, and South Florida, the main hub for trade with Central America, which is expected to get a big boost from the Central American Free Trade Agreement, or CAFTA.

Multifamily housing will benefit as interest rates move up on single-family homes, attracting immigrant and young households not ready to move into homeownership. However, this sector isn’t expected to see rent growth as strong as that in other sectors, in part because multifamily was never hit as hard as other sectors after the tech bust.

Nationally, multifamily vacancy rates have been heading down since before 2003, when they were about 6.5 percent. By the end of 2005, they were just above 5 percent.

Retail markets will stay strong, despite over-spent consumers, thanks in part to boomer household wealth. Retail vacancies have been coming down, although not at the rate of other sectors. A drop to 7.1 percent is forecast for 2006.

The office market is expected to be a big beneficiary of strong business investment, particularly in high-growth metro areas such as Washington, D.C., and southern California. Vacancies on a national basis are at their lowest since 2001. Job creation, along with discipline among developers not to overbuild markets, have led to a healthy balance between space absorption and new units.

“The economy is stronger and more resilient than anyone had anticipated just a few years ago,” Riggs said. “Our economy has weathered the most destructive storm ever, the tech bust, the terrorist attack, wars abroad, and accounting scandals. Despite all that, the stage is set for healthy market growth, and real estate is a prime beneficiary of that.”

The tables below give a statistical view of how some of the nation's economists expect the economy and the residential real estate market to perform in 2006, along with comparisons for 2004 and 2005.