Housing: Is It a Bubble If It Doesn't Pop?


By Amey Stone Forget all the chatter about the stock market. At summertime cocktail parties, the question on everyone's lips these days is: Are we in a housing bubble? Neuberger & Berman Real Estate fund manager Steven Brown says that's the one question he's most often asked -- and residential markets aren't even his area of expertise.

Consider that on July 22, the National Association of Realtors (NAR) and the National Association of Home Builders got together to put out a press release simply to refute the existence of a housing bubble. In it, they applauded Federal Reserve Board Chairman Alan Greenspan for telling Congress in recent testimony that the answer to the infamous "bubble question" is that "it is most unlikely."

Greenspan's wisdom aside, the truth is somewhere in between. If you define a real estate bubble as a period in which home prices are rising at unsustainable rates, then it's pretty clear we're in one now. On a national level, home prices climbed 8.1% in the first quarter this year over last year. That's pretty steep.

RECORD SALES. And in the fastest growing markets, such as metropolitan New York and Washington, D.C., prices grew 20% over the first quarter of last year. Home prices historically rise at the rate of inflation, now under 2%, plus a percentage point or two.

With mortgage rates at a 35-year low, sales of both new and existing homes are running at record rates this year. New-home sales in June hit a 1 million-unit rate for the first time ever. And NAR expects a record 5.5 million existing homes to change hands this year, even though their sales dipped in June. The pace of turnovers is at an all-time high as the average holding period of homes sinks to five years, from seven years historically.

Meanwhile, personal income levels inched up just 1.4% in the first quarter this year, after declining 0.3% in the fourth quarter of 2001. With home prices rising faster than incomes, that puts pressure on individuals to buy now or risk being unable to afford a comparable home a year from now, says Greg McBride, a financial analyst at Bankrate.com.

RATES ARE KEY. However, with the economy wobbly, the stock market at four-year lows, and the labor market showing only early signs of stabilizing, that could mean more people rushing to buy when their own financial well-being may be at risk.

The good news? As long as the economy keeps gradually ticking up, this latest real estate boom isn't likely to go bust anytime soon. Experts agree that low mortgage rates are the key to keeping the housing market aloft. And with this summer's decidedly mixed crop of economic news, most experts believe interest rates will remain at low levels for the rest of this year. "A bubble may not become apparent until we have a run-up in mortgage yields," says John Lonski, chief economist at Moody's Investor Service.

With rates now at just 6.34% for a 30-year fixed mortgage, home ownership is now affordable for more people, despite the higher prices. According to the NAR, buyers are spending 2.9 times their annual income on average to buy a home, which is inside the 25-year range of 2.5 to 3 times their income. "If we were to have rising home prices but declining affordability, that would be a perfect recipe for a bubble," says Lonski.

"A SAFE BET"? He professes amazement at how well the residential market in San Francisco has held up since the dot-com boom that had fueled its economy went into its death spiral. As of the first quarter of 2002, that metro region still had the most expensive median home price in the country. At $482,000, it had fallen just 0.4% from the first quarter a year earlier.

Real estate crashes, however, typically lag behind economic crashes, especially if a large imbalance between supply and demand exists going into the slowdown, warns author and investment strategist Peter Cohan,. His view: "Having lived through a couple of previous real estate bubbles I think it's a safe bet that we're in one now."

The NAR's own forecast is that the market should gradually slow to more sustainable levels. It expects national increases in home prices to decline over the rest of the year to a 5.5% 2002 increase and a 4% to 5% rise next year. Even if prices fall a bit in some overheated regions, they're unlikely to drop on a national level, says NAR chief economist David Lereah, noting that national home prices have risen every year the organization has kept records.

WITHIN ECONOMIC REASON. Greenspan would likely concur. In fact, he's so confident there's no housing bubble because he defines one as a period of speculative excess in which prices soar beyond any reasonable level. In most parts of the country, the spikes in home prices haven't defied economic reason, by any means. The inventory of homes for sale is at a record low, and many highly desirable regions have a shortage of developable space. Moreover, immigration has added to the pool of first-time buyers.

All this isn't to say that a bubble isn't building. It's clear from the economic and stock market data that Americans are far more interested in investing in their homes than in the stock market right now. And anecdotal evidence shows that people are viewing their homes increasingly as investments more than just as a place to live.

If past real estate bubbles are any indication, here's when you'll know things are ready to pop: When your friends start boasting at parties about buying properties for "rental income."

VICIOUS CYCLES. Given the mixed economic outlook, it's possible that the economy could go into a double dip while the housing market races on. That could lead to a rather vicious cycle in certain local real estate markets -- experienced last by homeowners in the Sun Belt in the mid-'80s and in the Northeast in the late '80s. In those regions, property prices plummeted along with local job markets, leaving newly unemployed homeowners stuck with houses worth a lot less than they owed the bank. That led to a crisis for banks and consumer confidence that took years to fix.

Most experts think that's unlikely to happen on a national level, however. Some bearish investors are worrying now about Japanese-style deflation in America's future. But that's about as pessimistic as it gets.

Doomsday scenario aside, homeowners and home shoppers fretting about where this overheated market will lead should keep in mind some general rules: Don't buy a home assuming it will be worth more in two years. It might not be. Also, don't sell your home because you want to cash out before the bubble bursts -- it may not pop for years to come.

It may sound trite, but for real estate, as with equities, a long-term buy-and-hold strategy is the best way to reduce risk. Stone is an associate editor of BusinessWeek Online


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