Bubble Pops Up In Housing Market

Just drop in to a neighborhood gathering or cocktail party, and someone is bound to be talking about housing prices. Financial adviser Ray Martin can tell you why, here as well as in his regular appearance on The Early Show.

According to the National Association of Realtors, home prices rose last year more than 8.3 percent nationally, and suddenly it feels like the real estate selling season this year will be a repeat of the year before, and the year before, etc.

The questions people are asking include, "Will it last?" and, "Is there a housing price bubble?" There appears to be no shortage of experts who agree that, although real estate prices have grown considerably, home prices are not likely to fall in the spectacular fashion that the stock market did in 2000.

The consensus is that real estate prices will likely grow, but at a slower pace, not at the annual double-digit percentage growth experienced since 1997.

The arguments that real estate and home prices will continue to rise indefinitely include a lack of available land, low interest rates and a never-ending supply of baby boomers and foreign buyers stepping into the market.

People who have forsaken their traditional line of work to seek their fortunes flipping real estate chide seasoned experts for not understanding the "new paradigm" in real estate. After all, they assert, people shouldn't be concerned over what they pay for a home, because home prices will always go up. And if home prices always go up, what you pay now doesn't matter anymore. These were the same points used to explain the nosebleed levels of the stock market in the late 1990s, and we all know how that story ended.

Price mania for any item can almost always be marked when the subject is a conversation topic at home, at gatherings and, yes, in the media.

So what's the answer? Will house prices continue to rise, or will the home price boom that began in earnest in 1997 turn into a bust?

According to Yale University economist Robert Shiller, the answer is: Be prepared for some shaking out.

According to Professor Shiller, he gathered a series of data on housing prices that go back 115 years, and the result was surprising: The U.S. has never experienced a home-price bubble like the one that began in 1997, except for the period right after World War II, when soldiers came home and went on a home-buying spree. His data also suggests that home prices generally appreciate about one percentage point above long-term inflation.

Signs of an overheated real estate market include the increasing number of buyers using interest-only and negative amortization mortgages to finance nosebleed high purchase prices, counting on future appreciation to build their equity. Also, according to the National Association of Realtors, about 25 percent of homes purchased last year were bought as investments, not as primary residences.

Potential trouble spots are in markets that have had double- and triple-digit price increases over the past five years, such as:

Boston, Mass.: 44 percent

San Francisco, Calif.: 78 percent

New York, N.Y.: 94 percent

Washington, D.C.: 97 percent

Las Vegas, Nev.: 103 percent

Miami, Fla.: 105 percent

Los Angeles, Calif.: 118 percent

San Diego, Calif.: 137 percent

Sources: National Association of Realtors (NAR), Bureau of Labor Statistics (BLS) and National Association of Home Builders (NAHB)A historical reference to the real estate market in Miami, Fla., is worth noting. In 1925, Miami experienced one of the most spectacular real estate bubbles in history. Soaring real estate prices were fueled by the perception that available land was running out, and a sense of urgency to buy pushed prices up in a frenzy. That story ended badly in 1926, and it appears that a similar environment exists today.

Despite rising prices, more people than ever are buying homes. Freddie Mac predicts that home sales will remain near record levels this year. And data from all over the country support this forecast.

Suffice it to say that home sales have seen significant growth and, in some areas such as San Francisco, Los Angeles, and particularly Miami, Fla., the market has been a flurry of sales.

It seems reasonable to agree that not all markets will experience plummeting home values. Instead, some areas may see price increases slow down or level out. Using the laws of reversion to the mean and compounding, it's a safe bet that the homes in the hottest markets probably won't continue to see double-digit increases in value for much longer. After all, trees don't grow to the sky.

Here's some advice to anyone considering their options in today's hot real estate market:

• Be an Informed Consumer. In today's market, buyers need more information than ever before. Visit a real estate agent to find out the median and average selling price of homes in your area, how much they have appreciated in value over the past several years, and how fast homes sell once they hit the market.
• Identify Hot Markets. Ask about the home-price-to-income ratio. This is the ratio of median home prices to incomes for a local area. If the median home price in an area is $240,000 and the median income is $80,000, this ratio will be 3, which is reasonable. If the ratio is over 5, then prices relative to incomes may be disconnected and it's possible that unsustainable forces are driving home prices higher.
• Compare Renting Vs. Buying. The decision to stop renting and to buy a home was traditionally made at the point at which the renter had saved enough money for a down payment and the costs of owning were only slightly more than renting. But now, some renters, anxious that the prospect of a continued rise in home prices and mortgage rates will put homeownership out of their reach, are jumping into home ownership even though the cost of owning is several times more than the rent they were paying. That may be fine as long as it's affordable, but when housing costs exceed 35 percent of gross income, and a prospective buyer has to make unsustainable budget cuts to make house payments, this is a problem.
• Consider Your Time Frame. If you've owned your home for some time and are considering selling it to relocate or change to a home more suited to your needs, it might be worth considering making your move sooner rather than later. Given Professor Shiller's research, we may be in the midst of an opportunity to fetch a high price before prices stagnate, or fall. If selling is in the plans in the next five years, consider making a move sooner.
• Consider Your Financing. If you own a home that has appreciated significantly since you've bought, it might be worth evaluating your refinancing options. The 30-year fixed rate mortgage is still below 6 percent, and if you've paid a higher rate because you weren't able to put down the 20 percent typically required to get the best rate, your home's appreciation may be benefit you now.

  Armed with a higher home value, you may now qualify for a lower mortgage rate. While you're at it, also apply for a home equity line of credit, even if you don't intend to use it: That could be easier to get, based on a higher home value.