It’s tough to ignore the economists and real estate pundits who see in the current marketplace signs of ebbing exuberance and cooling ardor. Professional brokers will agree that the frenzy of last spring is gone, and that is a good thing, they add. But are we headed for a freefall? Are we in the midst of a real estate bubble that’s about to burst? No, and no.
In 2003, the housing sector posted its best year ever. Prices, which had been rising at record levels for the last 8 years, shot up as much as 25% last year in markets like New York, Florida, California, Washington D.C. and Las Vegas. This rise came even as our choppy economy struggled to recover. In New York, real estate prices rose because of increases in personal income, mainly bonus money, and steady declines in interest rates. An inventory shortage led to competitive bidding with many homes selling over the asking price. As mortgage rates fell lower and lower, trading picked up speed and urgency, and property prices climbed higher and higher.
Economists see housing as a long term consumer product that is underwritten heavily by mortgages. While low interest rates kept the real estate market humming, they also contributed to a potentially risky financial scenario. As refinancing became the darling of the mortgage industry, property owners took out new, often larger loans on homes whose values were rising. According to a recent Fortune article, Americans have been using their homes like ATM machines, taking out 662 billion dollars in refinancing and home equity loans since 2001. In the last 3 years, it has not been unusual for homeowners to refinance as many as 2 or even 3 times, paying off their first mortgage plus any credit card debt, and then spending or banking what’s left. The wave of refinancing has stimulated consumer spending, but mortgage debt as a percentage of income is up significantly. Easy credit is especially risky for those borrowers who take on higher mortgage payments than they can afford who bank on their expectations that property values will soar in the short term. Gambling with your residence is never recommended.
Nonetheless, for the last decade, more and more homeowners have been considering their properties as more than shelter. Increasingly, real estate has been considered part of an overall investment strategy—a fact which has invited some comparison to the dot.com bubble of the late 90’s. Proponents of the real estate bubble theory see similarities with the technology boom and bust. Doomsayers declare that today’s housing is as overvalued as yesterday’s tech stocks.
A connection between the technology boom and real estate can be made. As investors and venture capitalists used their dot.com profits to purchase bigger and more expensive homes, prices and expectations were pushed higher. With supply low, and demand and anticipation high, buyers stepped up to pay record prices for their homes as they factored future price increases into their transactions.
However, there are some very important differences between stocks and real estate as assets. In the first place, changes in home ownership occur slowly. Unlike stocks which can be disposed of in a single phone call, it takes time, emotion and considerable expense to sell and move from a home. Secondly, while the stock market is based on national and global economies, real estate is influenced largely by local factors of supply and demand. Thirdly, there is nothing in real estate equivalent to the Wall Street short seller or hedge fund trader. Finally, it is impossible in real estate for a debacle to occur like Black Monday, when on October 19, 1987, the stock market plunged 22% in a single day.
For sure, there are real estate cycles. Experienced brokers readily acknowledge peaks and valleys. But while the tech bubble underscores an inherent industry volatility, the real estate market demonstrates a basic vitality. With 1990 as probably the last bottom seen in New York, and last spring the most recent high, veteran real estate professionals are looking forward to a mild reality check this season. Since runaway values stretch the limits of what is reasonable and sustainable, the leveling of prices is welcomed as a healthy correction. While prices may have peaked, they are not tanking. A crash in real estate will not occur, although growth this next year may be comparatively small. Some economists are predicting that home prices will rise an average of 5% annually for the next 10 years. Christopher Thornberg, a senior economist at UCLA expects that there will be “a drop in market activity and flat prices until the market fundamentals can catch up.” Conventional wisdom continues to look at residential real estate as bricks and mortar providing shelter and tax advantages. As a long term investment, it is also an important addition to any diversified investment portfolio.