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Cooler market may suck air
from bubble fears
Dear Steve:
I moved out of my home in Redondo Beach last summer and rented it
out. Its value has gone up $130,000 in less than a year. But I'm concerned
about the housing "Bubble Theory" and wonder if I should
sell. Even if prices go down 20 percent, it will still have the value
it had nine months ago. Has a "bubble" happened before,
and what is the worst-case scenario in Redondo Beach or California?
-- Bubble-Boy Glen
Dear Bubble Boy:
The old carnival-game bark, "Round and round she goes -- where
she stops, nobody knows," comes to mind when we ponder the
still-healthy U.S. housing market.
For our own fun and games, let's toss around some
of the prevailing economic philosophies and a few facts on this
much-debated subject, and you can decide if a housing bubble really
exists and if so, how close it is to bursting.
To some degree, the current bubble fears are a byproduct
of the stock market's tech bubble that burst following the giddy
dot-com days of the late 1990s. Unlike the stock market, real estate
isn't subject to such dramatic volatility, historically. In fact,
you'd have to go back to the Great Depression to find a wholesale
housing bust in the U.S., say economists.
Further, there's no way -- barring a worldwide catastrophe
-- that the housing market could lose 22 percent of its value in
one day as the stock market did in October of 1987. A home is a
good long-term investment, in part because there is little speculative
trading and overbuilding, unlike the oversupply syndrome that dampened
the commercial real estate markets in the early 1990s.
Some housing market "bubbles" have deflated
in certain states in recent years as other markets in the same state
soared. For example, when the tech bust hit, home values in San
Francisco dropped suddenly, while the rest of California faired
quite well on average. Of course, San Francisco quickly rebounded
after people began to discover that they could finally afford to
live there.
But there is some current evidence of unsettling trends:
- Studies show home prices rose at about the same
rate as overall inflation from 1950 to 1995. But since then they've
been tracking about 35 percent above inflation.
- Meanwhile, home prices have been rising faster
than gains in family income by about 2 percent nationally.
- Also, rent prices rose 2 percent in 2003
while housing prices rose 8 percent. The gap is even bigger in
Southern California.
I point that out because there is a theory circulating
out there that says a home, like the stock market, has its own price-to-earnings
ratio equivalency that really determines its value. Where the symptoms
of rapidly rising average home prices come up against slowly falling
market rents, the so-called "bubble" is pretty bloated,
it says.
Those P/E equivalents were reached in, ahem, Southern
California and a few other major U.S. markets in the mid-1980s,
and mild-to-severe real estate "corrections" ensued.
I do think it's safe to say that the U.S. housing
market is cooling. Last year's 7.5 percent gain in median prices
for existing homes is expected to slow to 4.4 percent this year,
according to The National Association of Realtors. Foreclosures
are expected to be high this year, as well. And many prognosticators
say interest rates will likely rise after the Presidential election,
regardless of outcome, a development that could have a marked slowing
effect on home sales and values.
Of course, some soothsayers say not to worry, because
the national home market is still as much as 20 percent undervalued.
And Fed chairman Alan Greenspan flat out denies there's a housing
bubble.
For a more detailed examination of the bubble debate,
read Holden Lewis' article in Bankrate, "Housing
bubble may be illusion, but choices are real," as well
as "Will
rising rates deflate housing prices?" by Bankrate's financial
analyst Greg McBride.
Then you can make your own bubble decision, Glen.
Good luck with it.
-- Posted: April 24, 2004
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