US house prices: more bubble worries?

April 17, 2005 | Uncategorized

In spring, while a young broker’s fancy lightly turns to thoughts of commissions, the home market heats up, as it runs on a circadian cycle, with enormous activity and anticipation in the spring. 

 

Are we in a bubble?  When will a bubble burst?  What are the indicators?  You can always find a pessimistic economist (not for nothing is it nicknamed ‘the dismal science’):

 

“We’re in a bubble, and prices could fall substantially,” said Robert J. Shiller, a professor of economics at Yale University and author of the 2000 book, “Irrational Exuberance,” which appeared just months before the stock market began its slide.

 

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And an optimistic realtor:

 

David A. Lereah disagrees. “There is no national housing bubble,” said Lereah, chief economist for the National Association of Realtors and author of the recent book, “Are You Missing the Real Estate Boom?“


 


“Any talk about the housing market crashing is ludicrous,” he said.


 


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“Hey, I’m not the dreamer! I’m the dreamee!”


 


Now that we’ve settled that via a consensus of expert opinion J, let’s look at some indicators, such as:


 


 


A recent runup in prices:


 


Although there are no official government tallies yet on how much real estate prices have gone up in the Washington area this spring, local real estate agents and builders estimate that prices may have risen about 15 percent just since the beginning of this year.  And that’s on top of the 21 percent they rose last year, according to the Office of Federal Housing Enterprise Oversight, a federal agency that tracks sale prices.  When it’s not spanking Fannie Mae — Ed.] Over five years, according to the agency, prices here have risen 89 percent.


 


 Bidding wars above the asking price:


 


The couple eventually won a bidding war by offering $26,000 more than the asking price.  “It was downright scary,” said Marshman, a first-time homebuyer.


 


It’s another insane spring in the local real estate market. As the prime season for buying and selling unfolds, very few homes are for sale, prices are climbing rapidly and desperate would-be buyers are bidding feverishly against each other.


 


It feels a lot like last spring, and the spring before, and the spring before that.


 


But now the question comes up more and more: How long can this last?


 


Renting has become relatively cheaper:


 


Renting suddenly looks like a bargain.


 


The gap between the cost of renting and the cost of buying, which historically move in tandem, has widened considerably in the Washington area, especially over the past year. It is now the widest it has been since 1989, just before the last real estate crash, according to a study by Torto Wheaton Research in Boston.

 

“The fundamental relationship between renting and owning has gone astray, which suggests there’s an overheating in home prices in Washington,” said Gleb Nechayev, senior economist at Torto Wheaton.  “There are two ways that the ratio could be restored to a historic norm.  Either home prices could decline, rents could rise, or both could happen.  The biggest contribution to this balance will come from home prices, we believe.”

 

Home prices much higher than rental movement means prices are being driven by investors who are amateur landlords:

 

Another worrisome sign to some economists is the high number of investors purchasing real estate these days. A recent study by the National Association of Realtors showed that one-quarter of all homes bought last year were purchased as investments, a high proportion by historical standards.

 

These amateur landlords are betting very heavily on appreciation:

 

Jennifer Tyler isn’t worried. She just took out a 10-year, interest-only loan to keep the monthly payments affordable on her new Capitol Hill house.

 

“Anything can happen in 10 years,” she said. “I can move.  I can refinance.”  She said that her interest-only mortgage, where no principal is paid for the entire 10 years — and thus she builds no equity unless the house value increases — saved her about $200 a month and made the difference between buying and not buying.

 

“Anyway,” she said, “the house will almost certainly appreciate, too.”

 

Indeed, they’re gearing more aggressively than many professionals would:

 

To afford ever-pricier homes while keeping monthly payments under control, buyers are routinely taking out interest-only loans, adjustable-rate mortgages or even negative-amortization mortgages, where a buyer borrows more than the purchase price of the home, something that worries even the most bullish of housing economists and builders.

 

“We’re bringing a lot of people with marginal credit into homeownership,” Wheaton warned.

 

Which means that if prices reverse …

 

Investors are considered more likely than owner-occupants to try to sell if prices fall.

 

Many are relying on low interest rates continuing:

 

Much of the boom in recent years has been sustained by low interest rates, which kept monthly payments down even as purchase prices rose.  But the consensus among economists is that interest rates will rise at least a little this year.

 

This could be gradual or it could be sudden (remember 1982?):

 

Interest_rates_1977_2005 

It wasn’t fun to buy a house in 1982 …

 

“One of the signals to watch out for with a bubble is the percentage of homes being sold to investors,” said Susan M. Wachter, professor of real estate at the Wharton School of Business at the University of Pennsylvania. “The only problem is that once you notice some of these signs, it’s usually too late.”

 

When will interest rates change?

 

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If he doesn’t know, how can we?

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