Interesting Story On Real Estate Bubble
Housing Prices
Continue to Rise
But New Study Suggests Bubble Mentality
Has Developed in Some of the Hotter Markets
By JAMES R. HAGERTY
Staff Reporter of THE WALL STREET JOURNAL
The latest bulletins from Realtors and home builders sound reassuring: The house party will rage on in 2004.
Cheaper mortgages have helped get the housing market off to a fast start this year. Most forecasts suggest prices will rise substantially again in 2004, albeit at a slightly slower pace than in the past few years. The National Association of Realtors reported Monday that sales of existing homes in December rose a stronger-than-expected 6.9% to a seasonally adjusted annual rate of 6.47 million units. The national median home price in December was $173,200, up 6.7% from a year earlier. For the full year, sales hit a record 6.1 million homes.
But the local market can be much different from the national average, and risks remain for people who have bought recently or are thinking of buying in some West Coast and East Coast markets. Price increases have been particularly dizzying there in recent years.
In a paper to be published soon in the Brookings Papers on Economic Activity, house-price gurus Karl E. Case of Wellesley College and Robert J. Shiller of Yale University find that the national measures of market trends can be very misleading. In most of the country, house prices tend to rise gradually, in line with personal income, they find. But California, New Jersey, New York, New England and Hawaii -- all of them short on land for building new homes -- are prone to lurch from booms to busts or periods of stagnation.
The upshot: Buying a house in a popular, land-starved place doesn't necessarily mean you will gain more in percentage terms over the long term. In the 21 years ended in the first quarter of last year, Messrs. Case and Shiller found, prices in Milwaukee more than tripled, about the same as in Los Angeles. The difference was that prices in Milwaukee rose steadily, while Los Angeles rode a roller coaster.
Now much of California is on another wild ride. Median single-family home prices in the San Diego area have surged 60% over the past three years, according to Fidelity National Financial Inc.
Vanessa Bachman, a paralegal, calls that number "terrifying." Even so, she and her husband, Richard, a radio-station promotions director, have just agreed to buy their first home, a $200,000 condominium, in the San Diego suburbs. "We kept waiting for [prices] to go down," Ms. Bachman says. "We finally decided to go for it."
Traditionally, falling prices have been the exception. The more common pattern is that a period of frenzied price rises in a city or neighborhood is followed by years of flat prices; buyers lower their offers, but most sellers hold out, waiting for better times rather than selling at a loss.
But even a leveling off can be painful for people who have stretched their finances to the limit and are counting on a quick killing in real estate to produce college or retirement funds, says Mike Sklarz, chief valuation officer at Fidelity National Financial Inc.
Nationally, the decline in interest rates has made housing more affordable for most people in recent years, even though house prices have risen. But Fidelity National's affordability index for some cities is worrisome. The index shows that the typical consumer in Miami can afford only 83% of the city's median house price. The readings are even scarier in Los Angeles (68%), San Diego (65%) and San Francisco (63%). Those numbers suggest that lots of people are getting priced out of the market, which eventually should help restrain prices.
Few housing pundits see much risk of a national plunge in house prices. Indeed, according to David Lereah, chief economist for the National Association of Realtors, there has never been an annual decline in the national median price in the past four decades. Even in the recession of the late 1980s, he says, prices edged up slightly.
January is likely to be another busy month because the recent drop in interest rates allows people to buy more house for the same monthly payment. The average 30-year fixed mortgage rate stood at 5.64% last week, the lowest since last July and down from 8.3% four years ago.
"It's very hard to concoct a scenario where housing is going to fall out of bed anytime soon," says Mr. Lereah. Demand for housing generally exceeds supply, he says. The recent numbers have been so strong that he is considering an upward revision in his forecast that the median house price will rise 4.6% this year and that sales of existing homes will total 5.8 million.
Home builders, returning from their annual show in Las Vegas last week, also are whooping it up. The National Association of Home Builders predicts that housing starts this year will be almost as strong as last year's record pace, despite earlier talk of a slowdown.
On a local level, though, prices do sometimes fall. For instance, data from Fiserv CSW Inc. show that prices in Los Angeles dropped about 29% from 1990 to early 1996. (Adjusted for inflation, the drop was 40%.) San Francisco had a decline of 14% in the early 1990s, and Boston slumped 16%. More recently, some Bay Area cities, such as Saratoga and Cupertino, have suffered steep drops, according to data from Mr. Sklarz.
Coe Lewis, an agent at Century 21 Award who represents the Bachmans of San Diego, says some people worry too much about prices. "They get paralyzed," Ms. Lewis says. "They almost overthink the process. They think there's got to be a dip. There's not going to be a dip. I'm not afraid at all of a bubble in Southern California."
Messrs. Case and Shiller, however, see signs that a bubble mentality has developed in some of the hotter markets. Last year they surveyed 700 people who had recently bought homes. The survey found that many of these people had very high -- and probably unrealistic -- expectations of how much home prices would keep rising. On average, respondents in the San Francisco area thought prices would rise nearly 16% a year over the coming decade.
Another sign of self-delusion: Some people surveyed thought prices in places like San Francisco and Boston should continue to rise faster than those elsewhere because they are such attractive places to live and there is little space for new housing. Those factors do explain why home prices in those cities are relatively high, the authors note, but they don't mean that prices should keep on rising at a faster rate.
Alas, write Messrs. Case and Shiller, "the single-family home market is a market of amateurs, generally with no economic training."
Updated January 27, 2004
Danger Zones
These are the 20 metropolitan areas that have had the biggest run-ups in median single-family home prices during the past three years. That could make them more vulnerable to stagnant or even declining prices.
AREA 3Q 2003 (in thousands) CHANGE FROM 3 YEARS AGO
West Palm Beach-Boca Raton, Fla.
$245.73 76.90%
Providence-Warwick-Pawtucket, R.I.
234.97 73.5
Nassau-Suffolk, N.Y.
370.73 72.9
Sacramento, Calif.
248.04 68.7
Monmouth-Ocean, N.J.
291.64 68.7
Bakersfield, Calif.
186.31 64.5
Riverside-San Bernardino, Calif.
226.9 64.5
Los Angeles-Long Beach, Calif.
361.54 64.3
Redding, Calif.
292.99 63.7
Fresno, Calif.
214 62.7
Miami
232.77 61
San Diego, Calif.
428.7 60
Fort Myers-Cape Coral, Fla
152.49 60
Merced, Calif.
220.45 58.7
Orange County, Calif.
499.35 58
Washington, D.C.
289.41 56.8
Fort Lauderdale, Fla
233.82 55.7
State College, Pa.
218.36 54.8
Stockton-Lodi, Calif.
263.9 54.3
Chico-Paradise, Calif.
260.09 54.1
Source: Fidelity National Financial Inc.
Copyright (c) 2003 | Dow Jones & Company, Inc. | All Rights Reserved
Here is another one....
The Bubbleologists Are Back!
By Alan Smith
It’s been about a year since we’ve heard talk of housing bubbles. But the unprecedented run up of home prices in U.S. housing markets over the last eight years has brought bubble talk back into the economic news and has revived the debate over whether or not a “bubble” exists.
As foreclosure property investors, we should take a look at the bubble question for some pretty obvious reasons. For one thing the very term “bubble” implies that it will, at some point, will burst. That as a result of the burst, a sudden implosion of home prices will occur. And such an implosion would mean that sellers would suddenly outnumber buyers by a wide margin.
Could it be true? Are we headed for trouble? Let’s take a look at what some of the leading housing economists have to say.
The most vocal of the pro-bubble faction is Dr. Dean Baker, co-director of the Center for Economic and Policy Research in Washington DC. Dr. Baker is absolutely convinced that there is a serious speculative price bubble, mainly on the west coast and in the northeast. Part of what has him worried is shown in the following table (excerpted from a paper published last August by Dr. Dean Baker and Simone Baribeau).
Metropolitan Area (in %) 5-Yr. Increase 1-Year Increase
Barnstable-Yarmouth, MA 97.69 13.74
Santa Barbara-Santa Maria-Lompoc, CA 89.09 14.96
San Luis Obispo-Atascadero-Paso Robles, CA 87.1 13.16
Vallejo-Fairfield-Napa, CA 86.11 12.45
Salinas, CA 85.34 7.63
San Diego, CA 84.7 15.20
Santa Rosa, CA 82.53 7.05
Santa Cruz-Watsonville, CA 82.2 5.41
Oakland, CA 81.9 7.69
Nassau-Suffolk, NY 81.74 14.97
Source: Office of Federal Housing Enterprise Oversight 2003
It’s interesting to note that all but two of the hottest metros are in California. Not all are areas that we service, but you get the idea. Baker states that there has never, in the recorded history of U.S. housing markets, been a price run-up like this, and in that, he’s right.
But is there really a bubble? Will these markets blow up?
At a seminar last year, Baker went head to head with some other top economists. He restated his thesis that a speculative bubble was forming in our housing markets, that it would blow up, and precipitate another recession.
He acknowledged that the steep appreciation curve in some markets could be due to the fact that those areas were simply more desirable as a place to live, but has maintained that a buying a home as an investment had become more important than buying one primarily for shelter and said that shift in emphasis had led housing into the realm of speculation.
He heard some strong arguments to the contrary.
David Berson, chief economist for Fannie Mae said that low inventories, plus restrictions on development in many parts of the country would prevent a precipitous decline in prices. He predicted a continued strong housing market throughout the rest of the decade and well into the next.
Frank Nothall, Berson’s counterpart at Freddie Mac concurred with Berson on the inventory element, and pointed out that the illiquid nature of residential housing did not lend itself to speculation. He cited the high transaction costs in buying and selling homes and pointed to the long holding period of single-family homes saying “average homeowners are in their homes for 12-14 years.”
It’s tempting for economists of Dean Baker’s persuasion to equate stock market and housing market bubbles and to see today’s homebuyers as treating houses as a commodity.
That, however, is comparing apples to oranges. Stocks are highly liquid, and have, as Nothall pointed out, uncertain cash flows and much shorter holding periods. Stock markets are also prone to periods of competitive liquidation when traders dump stocks because other traders are dumping stocks and get into a race for the exit. Disastrous price declines usually result, often in a single day.
Houses are just not trading vehicles. There are also social issues such as attachment to one’s home and employment situations that make both buying and selling highly individual decisions.
Mark Zandi, chief economist for www.Economy.com also does not see a housing bubble, but does see the possibility of price declines in some markets. Speaking at the same seminar, he said that “roughly 20% of the housing stock is at some risk of very little growth or outright price declines.”
Now, a few months later, we are beginning to see signs of change. Referring again to the chart above, notice that the one year increase in nearly every metro is well below the average for the five year period, a sure sign of cooling markets.
John Burns, a respected real estate industry consultant based in Irvine California, tells us that existing home sales fell slightly this month to an annualized rate of 6,060,000 and new home sales were also down slightly in November to 1,082,000 units. Burns also reports the supply is creeping up to a five-month inventory of unsold homes.
Baker seems to be outvoted, but he won’t budge. At the end of October, he published a critique of a study on housing bubbles by the Joint Center for Housing Studies at Harvard University in which he points (among other things) to the disparity between the Center’s projected household formation rate of 1.2 million annually VS projected new home production of 1.8 million units per year.
The U.S. population, however, moves around. California experienced population growth of over 600,000 last year, mostly from interstate and international immigration. The state has had growth of over 500,000 people per year for the last four years. In Arizona, the population is growing rapidly, and 20% of new home sales are to incoming retirees.
Burns also points out that builders are building to demand now, and a decline late last year and early this year in both building permits and housing starts proves that point. While supply to demand responses are not immediate, we can say that the equation is more self-correcting than it was in the last cycle.
On January 24, we received a note from economist Bertrand Roehner of the University of Paris. Roehner has long been an observer of U.S. housing, equity and credit markets. He is certainly far enough from the forest of our markets to see the trees.
We had written him about the bubble question, citing the mitigating factors of illiquidity, controlled inventory, population growth and demographic shifts, and the social aspects of homeownership that we felt, along with several others, would preclude a steep price decline or crash, Roehner wrote the following to us:
“I must confess that I didn’t expect the current price increase to last so long (author’s note: He has plenty of company on that point.). IIn any case, you are certainly right in that when prices begin to drop, that will be a slow and protracted process which is probably to take on the order of four to five years.”
So there you have it. While we very probably have bi-coastal overpriced markets, there is no speculative bubble. We’ll see a continued flattening or the price curve, and a modest decline in the overpriced metro areas.
In hot markets that have lasted as long as these have, people in our business are tempted to speculate on price growth, even though we know we shouldn’t. One reason is that, unlike most other real estate investors, we DO treat houses as a commodity. We have less concern for cash flow and plan on short holding periods. (Click here to learn more.)
While prices are still going up, foreclosure property investors should discipline themselves to plan on zero growth, and watch for the beginning of declines, especially on the West Coast. They won’t be steep, but they will come. We don’t know when, because the market is still feeling for its top. Don’t try to guess the top, but buy and sell on today’s values, not tomorrow’s. (Click here to learn how.)
Finally, while interest rates remain low there are more factors pointing to a coming increase than there are for rates remaining where they are. Any Fed action is of less immediate significance because a rise the Fed funds rate would primarily impact short-term rates.
Once again, we can’t ignore what one writer calls the “twin towers” of a $500 billion deficit and an increasing trade deficit. Those two issues must be dealt with and will put upward pressure on rates in the intermediate future. That will accelerate the cooling of housing markets that has already begun, and probably also accelerate foreclosure activity.
In the interest of brevity, as an economist (and R.E. investor), I can summarize. What goes up must come (or at least, slow) down.
I was pleased to note that of your 20 hottest 'bubble' R.E. markets, not a one of them is within a thousand miles of me here in the upper Midwest, though prices here have generally risen a lot too. There must be some connection between proximity to an ocean and liquidity--in a bubbling sense, anyway--of the R.E. market...
Well Real Estate has been good to me for the last 15 years, I can't say that about the market. I'll stick to real estate. But thanks for the info
Lori
[addsig]
My friends who do not involve in REI at all have been encouraged me to sell a few of my rental. With weak US dollar and employment, they believe that RE is the one gets hit.
I have not done that b/c with realtor commission and taxes, I don't gain that much. I figure that as long as somebody is paying the mortgages, I am happy. Besides I intend to keep them for long term. Any thought?