2006 Forecast

2006 Forecast:

All this brings us to a cautiously optimistic outlook for 2006. The market in 2006 should look a great deal like that of 2005, with economic conditions holding steady, interest rates rising but remaining at historically low levels, continued strong demographics, and relatively unchanged supply conditions. Sales are expected to decline 2% in 2006 from the 2005 record level, while the median price is expected to rise 10% from the projected 2005 median of $523,100 to $573,500. As such, sales will remain in near-record territory, while the median will reach a new high.
The market will continue to be buoyed by repeat homebuyers, who have accounted for 7 out of 10 purchases in recent years. These households will continue to use their equity gains from rising home prices to trade up or to buy a second home. However, would-be first-time homebuyers will find that it's increasingly difficult to buy a home with both home prices and interest rates on the rise.
A number of risks loom large in the year ahead. For one, higher priced parts of the state may face affordability constraints, which will hamper both sales and price appreciation. This is most likely to occur in the Bay Area and coastal Southern California, where price appreciation will likely fall below the statewide projection.
A second risk is an unforeseen dramatic increase in interest rates, because of a spike in oil prices or a significant flare-up of inflation that forces the Fed to raise rates. High oil prices and interest rates have tipped the economy into recession in past cycles. Fortunately, the economy has shown considerable resilience in adjusting to high oil prices over the past two years, so the likelihood of this appears to be low at this time.
A third risk is the increased use of low downpayment and interest-only loan products. To be sure, the vast majority of California homeowners hold fixed-rate mortgages, so the downside risk applies to those who have used these products in recent years. Still, it's unknown at this time how much the use of these products will affect foreclosure rates in the years to come.
-Robert A. Kleinhenz, Ph.D., is C.A.R.'s deputy chief economist