How to protect yourself from a
A reader -- we'll call him Ralph Marino because he didn't give
permission to use his real name -- wants to buy a house on Long
Island, where real estate prices have rocketed into orbit in the
past couple of years. He needs $20,000 just to make a 5 percent
down payment. He can scrape up only $10,000 -- and that's if he
borrows against his 401(k) retirement account.
"It would take me at least another year
or two to save another 10-15K," he e-mails, "and frankly,
I want to purchase a house before the costs are out of my reach."
The way Long Island real estate prices are going,
Marino has reason to worry. The Office of Federal Housing Enterprise
Oversight reports that home prices on Long Island jumped an average
of 4.08 percent from July through September and by 14.69 percent
in the 12 months that ended Sept. 30. If you're in Marino's shoes,
you look at today's $400,000 house and worry that it will cost $460,000
a year from now. That's what would happen if home appreciation on
Long Island remains at about 15 percent.
Compare his anxiety about rising home prices to the
frenzy that drove the speculative bubble in Internet stocks in the
late 1990s. People rushed to buy stocks in questionable companies,
certain that prices would inexorably rise. Then stocks crashed.
Is a similar speculative bubble inflating under real
estate? A few economists warn that home prices could collapse, just
as tech stocks did. But most experts say you can't really compare
houses to stocks. After all, you don't reminisce wistfully about
the cozy share of stock you grew up in.
"What is really different about housing
is that, if the market weakens, people don't start selling homes
like they do stocks when the market weakens," says Jeff Fisher,
professor of real estate and director of Indiana University's Center
for Real Estate Studies. "They decide not to sell their homes
unless they have to. They take their homes off the market so that
you don't have panic selling, resulting in further price drops."
If the bubble pops
Panic selling is exactly what economist Dean Baker, co-director
of the Center for Economic and Policy Research, worries about. Baker
says confidently that we are in a nationwide housing bubble, and
that when it pops, average home prices could drop between 11 percent
and 22 percent nationwide. Prices in some regions could fall by
40 percent, he says, as homeowners rush to sell before prices drop
Most economists say a nationwide housing bubble is
virtually impossible, but that local and regional bubbles can happen.
What if you live in one of those regions where there's a housing
bubble? How do you know? You probably can't know for sure until
prices tumble. Given this uncertainty, here are two pieces of advice:
- Don't buy your home primarily
as an investment.
Your home first of all is a place to live, so pick a dwelling
that suits your needs. Are you going to live there for just two
or three years? Then maybe it's better to rent than to buy. Are
two bedrooms sufficient? Then don't let a real estate agent bully
you into buying a three-bedroom house "because they make
a better investment."
"Whenever you decide to own rather than rent a home, you
are making a housing investment," Fisher says. "Perhaps
the most important thing is to not buy a house that is much more
expensive than you would be willing to rent to satisfy your needs."
- Be careful about how
deeply you go into debt.
Housing economists worry about what will happen to people who
have little equity in their houses if values plunge. Many people
are buying homes with down payments of just 5 percent or even
3 percent. Other homeowners take out home equity loans and home
equity lines of credit and end up owing almost the entire purchase
price of their homes. If values drop, these deeply indebted homeowners
could end up owing more than their houses are worth.
"If the value of their home drops unexpectedly
with a collapsing housing bubble," Baker says, "then many
families will suddenly find themselves with considerably less wealth."
That might not matter to a family that expects to stay in the home
for several years but could play havoc with people approaching retirement,
In a paper titled "The Run-up in Home Prices:
Is It Real or Is It Another Bubble?," Baker cites two main
pieces of evidence to justify his belief that there is a national
real estate bubble. First, housing prices generally have kept pace
with overall inflation in the postwar years. Since 1995, though,
"home sale prices have risen far more rapidly than the overall
rate of inflation." In those seven years, he says, home prices
have increased by 47 percent, while overall inflation has been 17
Baker's other piece of evidence is rents have increased
much more slowly than sales prices in the past seven years. "As
tenants are able to get better deals on rent, they will be less
anxious to rush out to buy homes," Baker argues -- and that
could retard or reverse home appreciation.
Baker says there is no rational explanation for the
run-up in prices. Not even demographics explain it, he says, arguing
that baby boomers exert less demand for housing as their kids move
out. People in the housing industry vehemently disagree, and point
out that we're in the midst of an immigration wave. Aging boomers
are buying many vacation homes, and their offspring are forming
families and buying houses. All of these demographic shifts result
in greater demand for homes and higher prices.
Bubble or nothing?
Len Zumpano, professor of real estate at the University of Alabama,
dismisses the notion that there's a nationwide housing bubble: "If
the prices have quadrupled in the past four months, you're in a
housing bubble," he quips.
On the other hand, Zumpano says the trend of rapidly
rising house prices "has been encouraged because of the bear
market over the past three years. People get burned in the stock
market and try to invest in tangible assets that can't decline in
Zumpano laughs derisively at the notion that real
estate can't decline in value. It has happened before in large regions.
Home prices collapsed in Houston, Dallas and West Texas in the mid-1980s
during an oil bust and the savings-and-loan crisis.
California, a boom-and-bust state since at least the
Gold Rush, has had periods of rapid rises and declines in housing
prices. According to OFHEO, prices continue to rise in much of Northern
and Southern California but have actually dropped slightly in the
San Jose area in the last year.
While Zumpano doesn't believe home prices will crash
-- at least not nationwide -- he does think the pace of price increases
will slow. He's just not sure when that will happen. He doesn't
rule out price declines in some local markets, "but I don't
think you'll see a correction like you saw in the stock market."
Most experts agree. Doug Duncan, chief economist
for the Mortgage Bankers Association, predicts that home prices
will increase about 6 percent nationwide this year and by 3 percent
in 2003. "In the broad market, we do not believe there is a
price bubble," Duncan says, but he adds that falling prices
in a few markets show evidence "of a bit of a bubble"
in those regions.
Duncan says he expects more foreclosures in 2003
as the rate of price increases slows down. If prices decline in
some areas, foreclosures will probably take a big jump, especially
among homeowners who owe more than their houses are worth.