What Do High Gas Prices Mean For The Housing Market?

Just our opinion, but spiraling gas prices may present an abundance of unintended consequences when it comes to the housing market. Some of these repercussions could ultimately be healthy, but other will pose some serious problems for consumers and the industry.

The Effect on Suburbia

Homebuyers have been making the trade off for years - the further away from metropolitan centers a home is located the cheaper it is likely to be. There are exceptions to this, of course, but generally consumers have been willing or maybe forced to exchange time for money, frequently commuting 40 or 60 or 80 miles each day between a nice home in the suburbs to their job in the city or in another far-flung suburb.

When I commuted 90 miles round trip in a mini-van back in the early to mid 1990s my gas costs were about $75 per month, an amount that did not include wear and tear on the car. With gas now near $3.00 per gallon that same drive would now cost at least $175 per month. This morning the news shows were talking seriously about costs of $4 to $5 per gallon by mid-summer in some locations. Not to mention that there have been spot gasoline shortages in many place in California and on the East Coast.

So, there is a possibility that homebuyers will find the price/commute trade-off is no longer feasible. This could drive down the price of housing in far-flung suburbs and put an additional premium on homes that are close in or with access to public transit systems.

For several years Freddie Mac and Fannie Mae have joined with local banks, employers, environmental organizations, and economic development agencies to sponsor programs to address what are called Workforce Housing Problems (see A New Take on the Company Store, October 2004.) These programs variously help employers develop a process to keep employees living closer to the office or to encourage developers, non-profit organizations, and municipal governments develop infill and rehabilitated housing in urban locations or close to transit lines. If all of the parties involved are really thinking about solutions to the current and the obviously long term problem they will push these initiatives.

There is also a faint possibility that energy prices will finally provide the tipping point and force local, state, and federal agencies to confront the need for more public transportation. Think of the problems that might solve.

The Effect on Interest Rates

Minutes of the last Federal Reserve's Open Market Committee (FOMC) held on March 28 were released last week. At that meeting the Federal Funds Rate, was increased by 1/4 points for the 15th time in as many months to a current rate of approximately 4.75 percent. The rate was at 1 percent in early 2004. The Committee minutes, however, revealed that most of its members "thought that the end of the tightening process was likely to be near, and some expressed concerns about the dangers of tightening too much, given the lags in the effects of policy." In real-people-speak this basically means that, in late March at least, the FOMC felt that inflation was in reasonable control and that they could stop raising those rates within its control which might mean that the mortgage rates that indirectly result from the Fed's action would stabilize near the current 6.5 percent range.

But, the devil is in the details and the minutes went on to state that participants "generally remained concerned about the risk that possible increases in resource utilization in combination with the elevated prices of energy and other commodities, could add to inflation pressures." In other words, don't look for any end to increases in the Federal Funds rate if energy costs continue to increase.

Freddie Mac, the National Association of Realtors, Fannie Mae, and other prognosticators have been pretty consistent in predicting an average annual rate this year for the 30-year fixed rate mortgage of around 6.5 percent. Best bet here is that, should oil go over $90 per barrel - the price is above $70 right now - all bets about interest rates will be off. The Fed under Alan Greenspan felt that controlling inflation was its overriding mission and that regulating interest rates was the best method of doing so. The new chairman has shown no indication of changing direction. The April or May meetings could provide some unpleasant surprises on this front.

The Effect on Housing Construction

Since higher energy prices will not be restricted to the gas pump, there could be profound repercussions on the cost of constructing homes and of operating them. First of all, it is a given that costs of material such as lumber and especially products which are petroleum-based are going to increase. Prices for materials will start a multiplier effect as transportation and ingredient costs and the energy required for production all rise. For example, dimensional lumber will cost more to cut in the field (oil to run the saws, cranes, and tractors) transport to the saw mill, run through the mill, and transport to wholesale and then to retail markets. Costs along each step will be passed on to the consumer.

If energy prices continue their upward climb homeowners are going to be unable to afford the big homes they have been demanding for the last two decades. In the early 1950's the average new home was a cape or a bungalow that ran 700 to 900 square feet. Today the average new home is at least 2,000 square feet and 5,000 to 8,000 square foot homes are no longer exceptional. The price of materials to build such a home, not to mention the builder's costs for electricity, transportation for waste disposal and so forth are going to force up the selling price and ultimately require adjustments to home size. Secondly, the homeowner may simply be unable to afford to heat more and larger rooms with cavernous cathedral ceilings, and energy gobbling bells and whistles such as hot tubs.

The good news is that homeowners may be forced to conserve both with simple measures such as turning off lights and more costly measures like retrofitting their homes with extra heating zones, low consumption appliances, and energy saving light bulbs. Already it is apparent that both housing developers and home owners are becoming receptive to some of the building innovations which have been pushed by green housing movements for the last two decades. We will be reporting next month on a survey of builders conducted by the National Association of Home Builders in conjunction with McGraw Hill about builder attitudes toward green building.

So we may be looking at a very different America as a result of increasing prices at the pump. This could result in revitalized urban areas, more energy efficient houses, or a reversal in the housing price/commute ratio that has driven development for several years. Or it could result in a situation where housing prices and interest rates have both risen well beyond the ability of average wage earners to cope with them.

And that indeed will cause the housing bubble to make one very large pop!