As home prices rise around the country it's been difficult to overlook an emerging thought: California has become our national pricing model.

The surge of home prices seen nationwide very much resembles what has been seen over many years on the West Coast and in a few other housing hot spots: Real estate values increase to a point long-regarded as unsustainable -- and then continue to rise.

In this scenario there is both good news and bad. If you're a property owner -- someone selling or seeking to refinance -- then rising prices are to be applauded. If you're a local government, rising home values automatically mean more tax revenues without the need to impose new taxes.

Alas, if you're a humble buyer then the constant pace of rising values makes ownership increasingly unreachable.

Despite rising prices, there is an argument to made that home prices are generally affordable.

"General housing affordability conditions remained favorable but declined in the second quarter, largely (as) the result of higher home prices," says the National Association of Realtors. (parenthesis mine)

NAR's housing affordability index, shows that a "median-income family had 120.8 percent of the income needed to purchase a median-priced existing home, which was $208,500 in the second quarter. The typical family, earning $56,917, could afford a home costing $251,900 in the second quarter."

I have no doubt that such information is mathematically correct and that nationwide the average household can readily afford to buy the average house -- unless that average house is in a major metropolitan area, the places where most people actually live. Then I have my doubts, given that in many metro areas the relationship between home prices and wage rates is grossly unbalanced.

As evidence, consider that in the first quarter of 2005 NAR reported that 66 metro areas showed double digit annual price increases. It doesn't take a study to know that income has not kept pace.

The catch is that it's not just exploding prices in metro cores. On a recent house-hunting trip we saw a well-maintained, modest home on a one-acre lot so far from downtown areas that cows ambled across the street. The price: $450,000 -- better than twice the national median value for a decidedly-rural location.

If you've won the lottery or just received a pharmacy degree, rising home prices are not much of an issue. But for many people swiftly increasing real estate values make ownership remote if not impossible.

What is causing rising home prices? In the main there are three factors:

• Demand is outpacing supply in most metro areas, in part because new construction is being limited with local building moratoriums.

• New mortgage products that reverse traditional levels of lender prudence -- flexible payment (option) loans, interest-only financing, stated (no tell) mortgages -- allow additional borrowing and bring increased numbers of buyers into the marketplace, fueling higher prices.

• Interest rates below 6 percent -- the lowest rates seen in decades -- continue to be available. Minimal inflation levels make low interest rates acceptable to lenders.

However every few weeks for the past year or so the Federal Reserve has raised short-term interest rates. The idea is to stem the oncoming tide of inflation, assuming there is to be an oncoming tide which requires stemming.

The result of the Fed's good works is that the federal funds rate -- the overnight cost of money to banks -- now stands at 3.25 percent. At the same time, Bloomberg reports that rates for the 10-year bond stand at 4.125 percent as this is written.

These numbers suggest inflation is being contained and that investors see little inflation in the future. This is good news for real estate because such perceptions tend to hold down mortgage interest rates.

The catch is that if the Fed continues to raise short-term rates they may soon hover above long-term rates -- creating what economists call an "inverted yield curve," a fancy expression meaning that a recession may be looming.

In effect, while the Fed has raised short-term rates nine times since June 2004, it has little room for additional increases before setting off recession worries. It will soon need to back-off short-term rate increases simply because low long-term rates suggest there is no meaningful inflation to contain.

The result? As improbable and contrary as it seems, pressure to extend low interest rates may continue longer than just about anyone thought. Such low rates mean strong real estate demand can continue and with demand still-higher prices.

California here we come.

For more articles by Peter G. Miller, please press here.

Published: August 9, 2005

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Peter G. Miller, also known as OurBroker®, is the author of six real estate books -- including The Common-Sense Mortgage -- and is the original creator and host of America Online's Real Estate Center. Peter's weekly columns appear in more than 100 newspapers nationwide, he is also published in a variety of other media outlets and he is a frequent speaker at national events and conventions. Peter welcomes your questions, comments, and news releases via e-mail at .