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Beholding the bubble


Does a real estate "bubble" exist in your area? Will it affect your investment in your home?

Pop goes the market: Responding to the bubble
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Like a balloon
What, exactly, is a housing bubble? It's a rapid increase in home prices that is followed by a steep decline. By that imprecise definition, housing bubbles are uncommon. Most booms end when home prices plateau for a few years. Those aren't bubbles. A minority of booms -- one-fifth, according to an FDIC study -- are followed within five years by busts. Those are bubbles.

Are you living in a housing bubble? You can't know for sure until it bursts. A bubble could pop, throwing home values down a flight of steep stairs. But it's more likely that prices eventually will stagnate for years while rents and wages catch up.

By the way, the aforementioned research paper by the Federal Deposit Insurance Corp.? It defined a bubble as a 30-percent rise in home prices in three years, adjusting for inflation, followed by a 15-percent drop in home prices in five years. The researchers counted 54 booms in 46 metro areas from 1978 to 1998, followed by nine busts that began within five years. The researchers spotted nine more booms that began after 1998, but none of those markets had popped as of the end of 2003, the latest data the scholars had. Since they haven't had time to pop, it's too early to know if those markets were bubbles.

Assigning blame
Economists, builders, real estate agents and others have attributed the steep rise in home prices to an array of factors, depending on the market.

Builders point the finger at laws that impose restrictions on land use and building density, and they complain that protecting endangered species puts prime home-building sites out of bounds. Recently the National Association of Home Builders encouraged the federal government to take the bald eagle off the endangered species list to "help landowners and others understand how to protect the bald eagle while continuing to keep housing affordable."

In other places, the bald eagle isn't the designated culprit, geography is. When prices were zooming in San Diego, real estate professionals pointed out that the city is bounded on the west by the Pacific Ocean, on the south by Mexico, on the north by military installations, and on the east by desert mountains. There aren't many places to expand.

Immigration is a widely cited factor in California, especially the southern part of the state. In South Florida, experts blame rampant speculation, as short-term investors buy condominium units and even houses long before they're built, on the assumption that they'll be worth a lot more after completion.

Speculation also seems to be the culprit in other markets that have boomed in the last few years -- Phoenix, Las Vegas, Boston, and New York City and Long Island, most prominently.

In their heads
The roots of housing bubbles grow in people's brains. When you bid up the price of something because you're sure the next buyer will pay even more, you have enlisted into bubble psychology. If most of the local market's home buyers join the ranks, prices spiral upward. Then, at some point, prices slow down or stop rising or even fall. In the latter case, a bubble pops. Sometimes there's an external factor -- a recession or a big layoff -- and other times there's no discernible reason other than people stop believing that prices will continue to skyrocket, just as they stopped believing in the tooth fairy when they were kids.

-- Posted: March 1, 2006
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