As home prices rise at 20% annual rates in some areas, many wonder if residential
real estate is falling prey to the same kind of wild speculation that
led to the stock market’s spectacular downfall.The answer, says UCLA economist
Edward Leamer, is yes — at least in many high-octane markets around
the country such as San Francisco, Boston
and San Diego. [Don't
get trapped in a housing bubble]
That MSN Money column describes the use of a Price-to-Earnings ratio
[P/E] for homes in a market, and concludes that the P/E's are dangerously
high in
a number of areas of the country.
The same conclusion is reached for a different reason (Greenspan did it) in
a column in the Los Angeles Times:
After his failure regarding the largest financial bubble in the history
of the world, it looks like Greenspan is now actively promoting the world's
second-biggest
bubble: the housing market.The basic story is simple: Over the last eight
years housing prices have outpaced the overall rate of inflation by
more than 35 percentage points. There is
no precedent for this sort of rise in home prices. In the past, home
prices largely kept even with the general rate of inflation.Studies have shown that, historically,
rents and home prices have appreciated together. In other words, underlying
factors will drive up home sale prices and rental prices by roughly
the same amount. The rental markets tell a different story.Continued on the next page Page 1 — Page 2
Article comments
1 - John Mudd
As I recently wrote for Paradise NEWS's upcoming January issue, prices will go up in 2004, while home sales will level off, in part due to interest rate increases of up to, or above 7 percent (possibly). This will not likely affect prices until 2005, when you may see prices slightly level off.
The massive supply of mortgage money, available cash and demand drive housing, not P/E ratios, which would be different for each individual purchase (i.e., single mom buys $145,000 home with 100% financing, having no original equity; wealthy couple buys $300,000 home in Tierra Verde, pays $200,000 down; single mom sells home in one year after buying to pay for son's college, but actually loses money due to lack of equity; wealthy couple pays for home, sells it after 5 years of owning to move back up north - one profits while one loses money, not because of the prices, but because of the amount of original capital invested in the purchase). Furthermore, stocks, as I told MSNBC last year, are intangible while property is tangible, so it holds vaue better than do stocks, which can lose value by saying one simple sentence about a company.
In 2003 prices stabilized earlier in the year, but started increasing in summer, slightly (the market I'm in). They will increase in spring of next year, but the supply of mortgage money decreasing, due to higher rates, will likely create another stabilization in 2005.
Real estate bubbles are a myth. Here's why: (1) They're tangible and hold value steadily over time (values tend to slowly increase, but a massive supply of economic stimuli can create a sharper increase); prices have continually gone up from 1900 (and before) to present (even throughout the Great Depression), but deflated money-borrowing costs can increase demand, which effects prices in the short-term, but they don't "pop" from $300,000 to $100,000 in any given market, as a bubble-myth proponent may lead you to believe, whereas, stocks actually do "pop" when artifically built up, however, real estate isn't artifically built up, but more people buy when the capital is available, increasing prices; (2) People love to buy and own property, and as long as they have access to the capital to purchase it, they will, although they may buy less when rates go up, and renters will rent for longer periods or perhaps permanantly if rates go up too high (I don't foresee that happening, though); (3) Property, because it holds equity well, which stocks and intangibles do not (try buying on margin, you'll see what I'm saying), attract investors of all kinds; when the markets are shaky, they move their money from it and put it into real estate, even if duplexes and other multi-family will make them less now then in say, two years (7% CAP rate's typical for my market, 9-11% if a really good property; flipping property is lucrative when rates are this low; when rates go up, CAP rates will be higher due to increased demand in rentals by renters who would've been buyers with today's interest rates and 100% and 103% financing availability); (4) Real estate markets aren't national or even statewide - they're all local and they differentiate from block to block, home to home, neighborhood to neighborhood (for example, one local area I do business in has $85,000-$120,000 condos, while another local area has condos that are from $400,000-$2,000,000).
U.S. World News and World Report printed an article last January saying the "Real Estate Bubble" would burst in 2003 and urged people to rent until prices dropped due to the "bubble" being "burst". The "bubble" is a myth pushed by Wall Street analysts who simply want the money back in their brokerage's coffers and by economists who have never practiced real estate, so they therefore base their analysis on theory, not on sound factual market information. I explained to a producer at MSNBC in January why the bubble was a myth, how prices creep up and down, how a tangible investment is different from an intangible one, etc., and they had a segment explaining why bubbles aren't possible in real estate. It appears Mr. Leamer missed it.
In real estate prices tend to creep up and creep down. They don't sharply go up then sharply drop, like a bubble, and since property purchases are subject to immense scrutiny by lenders, who will not give a loan for overly priced property, it would make it incredibly hard for a bubble to exist. If it did, an appraiser would say, "These properties are grossly overvalued" and lenders wouldn't take the risk and invest the money, but they're investing all kinds of money, and if they thought they would lose it, they wouldn't make it so easily available. A "bubble" would create all kinds of foreclosures, which would cause lenders to lose money, possibly break even on their investment.
Houses that are priced dangerously high are houses that don't sell, as I tell my sellers, "You can price it that high if you want to, but it won't sell anytime soon at that price...it could be on the market for a year or so." When houses don't sell, we Realtors have our sellers lower the price until they do sell. If their priced too high, a lender won't give a loan to the buyer, making the purchase impossible, without a large, independent cash infusion, which does create an equity problem for the buyer (this is rare, because most Realtors won't show overpriced homes, except to sell their own listings). Prices will go as high as the market will bear, and when the market won't bear them anymore, sellers will lower their prices, plain and simple, or they won't sell. If you buy an overpriced house, then your Realtor didn't do their job and show you comparable solds, which can give you a snapshot of what homes sell for in a given area, and the sold price is its value immediately after the purchase.
Prices will level off again, likely in 2005, but the bubble is about as real as a Stephen King fictional novel. A UCLA economist without an appraiser's license or a real estate license is hardly an expert in the tangible asset of real property and they should be taken to task for making false representations of value by valuing property based on a P/E ratio without knowing the facts of each individual transaction, and the P/E will be different on EVERY transaction, depending on how much was put down and how much was borrowed, and how much properties are selling for in any given local market.
2 - Hal Pawluk
Really? I wish I'd know that when I lost $600,000 in the housing market drop here in Southern California about a decade ago.
Averages and "tendencies" don't count. Prices in various regions can go up sharply, and come down just as sharply. In my region they've been going up 20%/year plus, and houses sell quickly, in some cases selling for more than the asking price.
It's highly likely that we're going to see a price drop, as the first two articles predict - it has happened before so there's no reason it won't happen again.
Mind you, if Inman can guarantee otherwise, I'll go out and buy another house or two.
Let's talk again in a year or two.
3 - John Mudd
Sorry to hear about your loss, Hal.
The Southern California market, from what I can tell, does have some interesting fluctuations, and I can understand what you're saying based on that market. However, the California market is so far out there (I say that based on some investor-clients of mine telling me you can get a 2/2 in San Diego for around $700,000), that it's not at all a good indicator of what's going on nationally.
Florida is also a bad indicator, too, since most areas are usually sellers' markets.
Colorado, on the other hand, is a bad indicator, since it often trends as a buyers' market.
Austin, Texas is now a buyers' market, even during the real estate "bubble", so it's a bad indicator, whereas, Dallas, Texas is probably a good national indicator, currently, if one place is used, but I don't recommend it, since every market varies greatly.
A price drop will occur at some point, but it will be more of a leveling off (prices leveled off up to $60,000 here in some areas this year), not a "bubble" bursting. Real estate investments are easier to lose money in that real estate residency purchases, especially if you don't have accurate information or don't run the formulas to calculate investment returns, however, they can also be quite profitable when all the numbers are right.
4 - Hal Pawluk
Apparently the worst areas right now are Southern California, San Francisco and Boston.
The idea of checking what rentals are doing relative to house prices in a particular market struck me as an interesting and useful tip.
5 - Ames Tiedeman
Nice article...