Global Trend

Housing Boom Peaks Out, But No Collapse Yet

We are in the midst of . . . the biggest world-wide housing boom ever,” declared Robert Shiller, the Yale economist and author of Irrational Exuberance. In August 2004, sales of new homes went up by 9.4 percent, the biggest increase since December 2000.

By the end of 2004, a record number of new homes ? 1.2 million ? are expected to be sold, according to the National Association of Realtors.

And, according to recent articles in Bloomberg News, many builders are reporting that they are selling homes even faster than they can build them. For example, even if Toll Builders of Huntington, Pennsylvania doesn’t sell another home for the next 30 days, it would take 11 months to fill its backlog of existing orders. With nearly 7,000 units ordered but not yet delivered, Toll Brothers values that backlog at $4.35 billion.

Figures from the U.S. Commerce Department show that housing prices are 9.7 percent higher than they were during the same period last year.

Is the real estate boom headed for a bust? According to Shawn Tully in Fortune magazine, “The housing market is rapidly losing touch with reality. Fueled by interest rates that have remained near record lows, prices have continued to soar, and the gap between home values and the underlying fundamentals such as personal income and job growth is greater than ever. The most alarming development, though, is the change in psychology.

“‘The market isn’t acting rationally,’ says Christopher Thornberg, an economist at UCLA. ‘It’s now an emotion-driven market where people are buying on the expectation of future appreciation.’ Increasingly, Americans view houses not primarily as places to live but as foolproof, can’t lose investments. The passionate faith that money poured into real estate will magically multiply is creating a self-fulfilling speculative frenzy that’s bound to end badly.”

The real estate bubble is concentrated on the coasts. In cities like Cleveland and Dallas, prices have gone up gradually, in the low single digits. But in New York, Boston, Washington, Los Angeles, and Miami, home prices have surged 60 percent since 2000. In San Diego, the increase is an astounding 76 percent, which has pushed the median home price to $582,000.

Every month this year, an average of 660,000 houses are sold. That’s 50 percent more than during the mid- to late 1990s, according to Tully. He quotes a realtor in Virginia who says that buyers know that if they wait another month to close a sale, the price will go up another 1 percent. In other words, for people who are in the market for a $750,000 house, shopping around for 90 days adds $22,500 to the sale price.

Naturally, most buyers jump to the conclusion that if prices are going up 1 percent every month, the house they buy today will be worth 12 percent more a year from now. With interest rates low, this beats the returns on most investments.

But that approach will only work if prices keep going up ? and, as history has proven in every mania, from tulip bulbs to dot-com stocks, prices of overvalued investments always collapse, crushing people who got caught up in speculation.

Making matters worse, homeowners have taken some $662 billion in equity through refinancing on the new inflated values since 2001. This ready cash has helped support the economy during slow times in both the job market and the stock market. Thus the housing market has defied historical trends by remaining strong even during times of economic stagnation.

In light of the current recovery, nation-wide median home prices have ballooned by 47 percent since 1995. Compare the period of 1982 to 1989, when prices rose just 14 percent. Even with that comparatively small jump ? and it was a jump ? there was a cost to pay after the party was over. Between 1989 and 1994, prices fell 5 percent in a correction.

It appears that all the money that people were happily putting into the stock market in the 1990s is now going into the speculative home market. In California, more than 3 percent of buyers sell their houses within six months ? the real estate equivalent of the day traders of Internet stocks in the 1990s.

One survey showed that homebuyers expect prices to rise 20 percent a year for the next decade, which economists say is wildly unrealistic. And in hot markets like Miami, speculators are flooding the market with hundreds of new condos. This overcapacity is bound to drive prices down sooner or later. In many of those markets, speculators ? which make up an incredible 40 to 70 percent of homebuyers ? put down 10 percent of the purchase price for a unit that won’t be ready for another 18 months. If the market collapses, they’ll simply walk away, leaving the condos bankrupt.

This already happened in Las Vegas, where investors drove up prices between November and May. When the fundamentals caught up, they simply walked away. The number of homes for sale in Las Vegas went from 4,000 to 14,000, and the time to sell went from a few days to several months. Prices fell 1.2 percent in July alone. With rental prices at record lows and housing prices at record highs, the signs are clear that in many other markets the housing boom could be peaking and getting set to flatten out.

The relationship between income and housing prices is also telling. Between 1975 and 2000, a normal price for a home was about 2.7 to 2.9 times the median annual income ? and that figure was already considered on the high side. In some markets, such as California, this number is now a mammoth 6.4 times. To get back to a 2.9 level, housing prices would have to stay flat for the next five years.

Another factor is the Age Wave. As the millions of Baby Boomers begin to reach retirement age over the next few years, the urge will be strong to cash out their equity from their homes and move to condos in resort communities. Coupled with the smaller size of Generation X, it appears that the supply of houses will outpace the demand.

Looking ahead, we foresee five developments arising from the housing boom:

First, the real-estate bubble is likely to keep growing until interest rates, real estate taxes, and Baby Boomer retirements make an impact on home sales. In all likelihood, there won’t be a major, nation-wide crash in the real estate market. With sharply rising interest rates unlikely and the economic recovery fully under way, it will probably just peter out to more realistic levels, with a few super-heated markets on the East and West Coasts experiencing more painful contractions.

Second, the boom will be followed by several years of flat prices or slight declines. For people who plan to buy a house today that they’ll live in for the next decade, there’s no reason to hesitate; the boom-and-bust cycle will completely play out by the time they’ll sell their homes, and another boom will have begun. By contrast, anyone who’s looking for a place to live for just the next few years should consider renting, according to Tully, because that’s where the best bargains can be found. The ratio of median home prices to annual rents is 15.2, the highest it’s been in two decades, based on data from Fidelity National Financial.

Third, anyone who is planning to sell a high-end home in the next few years should do so between now and the Spring of 2005. However, we call your attention to an exception to this rule offered by futurist Harry S. Dent, Jr. He notes that the Southeastern United States will remain a bright spot for continued appreciation, because of three reasons: (1) housing prices are still undervalued relative to the rest of the nation; (2) migration rates are the highest as people move there from other parts of the country and from overseas; and (3) the ages of the peak Baby Boomers are about five years younger than in other parts of the country, which means they will continue to trade up to larger, more expensive homes for a few more years.

Fourth, any slowdown in the real-estate market is likely to have an impact on the rest of the economy. The real-estate sector now accounts for 25percent of the overall economy. Thousands of real-estate agents would lose their jobs, speculators would lose their investments, and companies that rely on a strong real-estate market ? such as construction, moving, furniture, and home improvement businesses ? would see their profits fall. And the refinancings that have fueled consumer spending would dry up. In the first quarter of 2004 alone, Americans collectively took some $840 billion out of their homes, the highest figure ever recorded. If real-estate values fall or turn flat, refinancing

and spending would stop, which would hurt the rest of theeconomy.

Fifth, the good news is that the housing market will be buoyed by the continued demand from immigrants. Every year, about 1 million immigrants come to the U.S., and many of them eventually purchase homes. This will help to offset the falling demand for houses among U.S. citizens.

References List :
1. Irrational Exuberance by Robert J. Shiller is published by Princeton University Press. ⓒ Copyright 2000 by Robert J. Shiller. All rights reserved.2. To access their report on the housing market, visit Bloomberg’s website at:Quote.bloomberg.com/apps/news?pid=1000000&sid=a0ApWZQEtWIY&refer=home#3. Fortune, September 20, 2004, "Is the Housing Boom Over?" by Shawn Tully. ⓒ Copyright 2004 by Time Warner, Inc. All rights reserved.4. H.S. Dent Forecast, October 2004, "Real Estate Update: Signs of Slowing, But Prices Might Rise a Bit More First," by Harry S. Dent. ⓒ Copyright 2004 by H.S. Dent Foundation. All rights reserved.