Bubble or no bubble, that is the question
April 14, 2004 6:37 AM   Subscribe

"The real estate bubble's gonna pop!" You seem to hear that all the time... But dig deeper and you find that other people don't even think there's a bubble. Others think there's a bubble, but it's gonna keep growing. Then, just to make it interesting, you've got others who said the bubble was going to pop back in 2002. Why is first-time home-buying this friggin' difficult?!
posted by lazywhinerkid (34 comments total) 2 users marked this as a favorite
Some think there's a bubble, some not... When did I hear that before? Oh, yeah, 1996.

I'll leave this to greater economics minds that I (haven't been an amateur economist since MicroEconomics 303), but the combination of no real growth in wages, stagant equities and bond markets, accelerating federal budget deficits (+ increased govt. spending on debt service) putting downward pressure on the dollar, increased property taxes at the state level to make up for revenue shortfalls... bubble or not, I suspect we're due for some kind of correction in the home real estate sector in the next few years.
posted by psmealey at 7:05 AM on April 14, 2004

There are a few reasons to buy a house. One is as an investment. Another is as a place to live. I bought my house because I have a stable job, I like where I live, and I don't want to pay rent to someone and pay for their investment. Renting is great for many reasons, but I want to have a home that is mine where I can dig in the dirt and paint the walls, and have my dogs as well without having someone looking over my shoulder. The downside is that when the roof needs replacing, or the furnace breaks down, that comes out of my pocket. And, I can't just pack up and move on a whim without putting the place on the market or renting it out. I do think you'll find real estate bubbles, but I think you'll find them more local than on a national scale. The population in the United states continues to grow, and people need places to live. Having said all that, my house has been my best investment to date.
posted by Eekacat at 7:15 AM on April 14, 2004

Well, yes Eekacat, but it wouldn't be much of an investment if that $750,000 home you bought in San Fran was suddenly worth half that. I mean, I know you said you had a stable job, but what if you decided you wanted to relocate for some reason?

I've been planning for years to buy a house, and this summer I had actually planned on doing it. Now, I'm sure Austin isn't likely to be as bubbleified as Cali, but I'm sure a collapse there is going to ripple outwards. It just isn't fun to think that suddenly my "investment" could be my albatross.

You people in California ruin everything!
posted by Swifty at 7:49 AM on April 14, 2004

We just finished selling our first house and buying our second. I know we were amazed at the price we got for our house and am pretty sure the people we just bought our next home from are pretty amazed at what we paid. Our first house was a struggle to get into - but the investment grew by over 100% in just 6 years (sold it for twice what we paid for it). I can see now why there are a lot of breaks for first-time buyers, because it's a lot easier to roll from one home to another once the initial investment has built up.

From what I heard on NPR last night, there's no real jump in investment buying - buying-and-residing is remaining steady, interest rates are still amazingly low, and inventory remains tight. If it's a bubble, it's either a really resilient one, or it's going to burst badly. I prefer to think the former is the case (hoping not to get burned on this most recent investment).
posted by kokogiak at 7:50 AM on April 14, 2004

I'm not an economist nor do I know much about economics. Therefore, I will comment. It seems to me that everybody who was previously pouring money into the stock market decided that real estate was the way to go and poured all of their remaining money into that, helped by low interest rates. Not only that, but it seems like most of the people who were going to buy have bought or are buying, leaving only the smaller market of people who are just becoming ready to buy.

At least that's what I'm banking on as I continue to rent. ;) (No, I'm not hoping other people get screwed, just that when I'm ready, there will be affordable housing around.)
posted by callmejay at 7:51 AM on April 14, 2004

(It's possible that my comment was already disproven by kokogiak, who cynically waited until after I previewed to post.)
posted by callmejay at 7:54 AM on April 14, 2004

I think one of the defining characteristics of a bubble is the general consensus that a bubble is not taking place. In the late '90s, there was a lot of talk about "new paradigms" as traditional methods of valuation were thrown by the wayside. Having suffered the inevitable consequence, we are now wary of any rapidly growing market, and fearfully expect the next market collapse at every turn. (And it bears repeating that there is no national real estate "market," rather, there are multitudes of smaller, regional markets, each of which is subject to local factors.)

The real estate market simply is not as speculative as the equity or futures markets (I would argue that the illiquidity alone provides an inherent price stabilizing mechanism). Indeed, owning a home provides much more intrinsic value than owning 1000 shares of MSFT. Although there will certainly be a consolidation period in the future as interest rates return to more traditional levels, the many benefits of home ownership and an ever-increasing population should buffer future declines in real estate values.

[/armchair economist]
posted by malocchio at 8:07 AM on April 14, 2004

I can only comment as a first-time homeowner. We bought back in 1999 for 300k. I've just been told by my realtor that, should I decide to sell this year, I could easily get in the high 500s for the house.

I've done nothing to improve it.

I have to suspect that there's some bubbling going around.
posted by thanotopsis at 8:10 AM on April 14, 2004

Things are much the same in the UK. People have been living in a rising market for so long that they treat it as inevitable - you buy a house, you sell it for more - and can't grasp that trends could quite easily go otherwise.
posted by raygirvan at 8:20 AM on April 14, 2004

Malocchio - funny you should make the MSFT stock a talking point. In 1999, shortly after moving into our first house, during the heady Internet Bubble days, I had the good fortune of being able to choose from two job offers - one on the microsoft campus, one at a startup. I chose the startup, and always wondered if I'd regret passing up the MSFT stock options, so I noted the stock price (around $50) and have kept an occasional eye on it to see. Considering that it's trading at $25 today, I don't regret missing out on that now. Just some perspective on growth in investment (my home vs. my possible stock) in the same area and same timeline.
posted by kokogiak at 8:22 AM on April 14, 2004

Swifty, look in East Austin. The land is undervalued now, and most realtors avoid it out of habit. There are treasures to be found, though, if you are willing to live in an offbeat urban setting. The French Place area and just south are good bets.
posted by whatnot at 8:26 AM on April 14, 2004

While it's sensible to theorize that housing prices will always increase [increasing demand + inventory increasing at slightly lesser rate than demand = steadily increasing value of inventory] as population outstrips new home construction, it's always a little more complicated.

Even in my own lifetime, I can remember at least two prolonged periods when the home buying market (in SE Connecticut, which is some pretty prime real estate) was in retreat. In the late 70s, and in the mid 1980s. My personal recollection is that my parents bought a home for $225k in 1977, put it up on the market in 1982, got an offer for $189k a year later, declined, put it up for rent, and finally sold it for more than it was worth in 1984. Incidentally the same home was sold about a month ago for $1.1MM.

Don't want to be a doomsayer, not do I wish ill fortune on anyone, but like callmejay, I'm still waiting for an opening... of course getting back to my pre-2001 income level would help a great deal in that regard as well!
posted by psmealey at 8:39 AM on April 14, 2004

kokogiak: MSFT had a 2 for 1 split during that time, so actually you wouldn't have lost anything.

I think the big bubble-burst will happen when all the baby boomers begin to move into old-folks homes or die off. Most of these people own their own homes, and could provide a supply glut.
posted by falconred at 8:45 AM on April 14, 2004

Aha, thanks - missed that split, still, I don't regret, since it was options, not actual stock.
posted by kokogiak at 8:56 AM on April 14, 2004

Eekacat - Houses that you buy and live in are not an investment, in fact they're not even an asset unless you sell them. For most people, they are a liability (i.e., the cost of the monthly payments, maintenance, etc).

The only true real estate investments are either the somewhat speculative REITs (Real Estate Investment Trusts), or the highly speculative approach of building a house to see if someone will buy it. As soon as the bubble breaks, (and yes, I do believe there is a bubble), there is going to be a nasty game of real estate hot potato among investors. Individual homeowners won't be affected too much, as long as they can afford their monthly payments, and don't rely on their equity to bail them out of other debts.
posted by grateful at 8:56 AM on April 14, 2004

Some of you might have missed the old thread, so I will just shamelessly copy and paste my previous comment.

While there are elements of a bubble - waiting in a tent to be the first in line to buy a house and "over the budget" loan offers - there is a possibility that things might not be as bad as they seem.

Enter the "Greenspan argument": new financial instruments are available to lower the risk, thus an increase in level of debt is not a burden. For homeowners, refinancing means lower monthly payments and /or higher loans.

CAPM / Equity Risk Premium Puzzle literature says that people should pay higher prices for assets which provide high returns during periods of low consumption (recessions). Stocks pay during booms, when one already has higher income, so they are not “very useful” from that perspective (more here [pdf]).

House prices tend to go up (in nominal value) most of the time, however nearly all growth takes place at the end of the boom and during the recession that follows [pdf]. Since interest rates are high at the end of the boom and get lower afterwards, most people will tend to refinance during a recession. The financial instruments allow them to benefit from the price increase without relocation (high transactions costs).

This is something new in the market: while house prices had the same evolution before, people, in most cases, were unable to extract the surplus. Thus, a house has become an asset that pays during periods when normal income is low, and, hence, part of the price increase is justified by the new found use.

A word of caution: the above is not an empirical fact, it just a hypothesis that waits to be proven right (or wrong). We cannot use past data to test it since the financial instruments were not commonly used during the ’91 recession; we have to wait for few more data points.

If this theory holds, I would also expect to see a steady increase in house prices (ignoring the bubble effect) for the next several years, as more people realize the value of “old assets.”

What happens when the boom starts? Even if prices were to go down in nominal value (little empirical support) so that the value of the loan will be higher than the house price, most people will still pay the mortgage - the default brings too many bad consequences. Moreover, it should not be a big problem for the household, as employment should start to become available and stock prices go up. Hopefully, house prices will go up again as more people will afford them (higher income and stock earnings for the duration of the boom).
posted by MzB at 9:06 AM on April 14, 2004

pmsealey - I'm certainly not arguing that home prices cannot go down, often for prolonged periods. Recessionary times and periods of high-interest rates will certainly have a negative influence on real estate, and I believe that a similar 10-20% correction in the next few years is not unlikely. But I would hesitate to label any such correction as a "bursting of the bubble" unless we see far more catastrophic declines of 50% or greater.

falconred - look at a split-adjusted chart. MSFT is today trading in the same range that it first reached in late '98. Buying and holding MSFT over that period would result in virtually no capital gain.
posted by malocchio at 9:09 AM on April 14, 2004

oops - falconred, my apologies...please disregard my comment. I misread kokogiak's original statement.

my first mefi mea culpa! may they be few and far between!
posted by malocchio at 9:51 AM on April 14, 2004

We just put our bid on our first house today. Who KNOWS what returns it will give us, but if we reside for a long while there, we will be able to get back a chunk, and still have paid relativly little (compared to rent) for being in a house for 7 to 10 years.

If everyone was a little less greedy, the whole world would be better off.
posted by psychotic_venom at 10:07 AM on April 14, 2004

Thanks LWK for bringing up the great unspoken. I'll shamelessly put a link to a post I wrote a few weeks ago about this on my blog -- the point being that a conspiracy theorist (unlike me) might say that the media (who gain tremendous revenues from classified ads), the government (including Freddie Mac and other subsidiaries), realtors (which has lately become an industry to be reckoned with), and homeowners (who have a stake in skyrocketing house prices) are creating this bubble (shamelessly). More relevantly, I find it sad that buying a home of any kind (co-op, condo, house) in the NYC region (where I reside) is next to impossible for most newbies.
posted by boardman at 10:20 AM on April 14, 2004

grateful, that was my point that there was more than one reason to purchase real estate. Kind of a response to lazywhinerkid's comment about first time home buying. Buying a home and investing in real estate are 2 different things. And yet, if I sell my house today for the conservative estimate of it's value, I will have made over 200% on my investment in the place in 5 years. (Yes counting the payments I've made and the cost of improvements and deducting the interest). Pretty good ROI if you ask me, and I get to live in a funky old rock house too!

Swifty, I don't live in CA, I did at one time and lost money on the house I had there since the economy was crap when I moved. I worked hard and saved up for another down payment, and I am doing quite well now. Losing money was certainly a consideration when deciding to relocate, and I am glad I did. I took a step back to make a step forward. If I was thinking of buying a 750k place, I certainly would hope it wasn't my only asset. I don't make the kind of money that would allow me to afford to live in such digs. I own a house, but I am not a slave to it. The house I live in now could lose half it's value overnight, and would still be worth more than the mortgage I have on it. Sometimes leverage can hurt as much as it appears to help.
posted by Eekacat at 11:13 AM on April 14, 2004

As a first-time homeowner you should not worry about it and just buy the house you like as soon as you can.

The reasons are two-fold in my mind. First, if real-estate prices drop the interest rates will rise. So either way, it ends up costing you the same really. Second, the average home buyer owns a home for 7 years. Historically no downturn has lasted that long so even if you get in at a bad time you will probably live there long enough to see it turn around.

There is more risk in not buying. I was worried about the bust and so didnt buy back in 2001 and waited until 2003. I regret that very much I lost a lot of upside in the market over those 2 years and wasted a lot of money on rent.
posted by stbalbach at 11:43 AM on April 14, 2004

Wasted money on rent?

You had a roof over your head, didn't you?
posted by ilsa at 1:30 PM on April 14, 2004

This real estate bubble is a pimple filled with trophy-house puss.
posted by troutfishing at 2:40 PM on April 14, 2004

The money was wasted because had I owned the house instead I would have effectively spent nothing to have a roof over my head. I would have made back the mortgage payments through the increased value of the house.
posted by stbalbach at 4:02 PM on April 14, 2004

Well, just think about it this way: you bought yourself the option to bail out and move anytime you wanted.
posted by Mars Saxman at 6:58 PM on April 14, 2004

Housing prices in Baltimore (you know, Charm City) have gone up 20% in the last year, 41% in the last 3 years. Houses in the neighborhood where I live that were $90,000 6 years ago now go for $180,000 or more --- we're talking a rowhouse with less than 1000 square feet. I've seen houses go on the market for $300,000 that were a block from an open-air drug market.

Real estate bubble? Couldn't be...
posted by QuestionableSwami at 7:31 PM on April 14, 2004

Well there's a couple things to think about. First I'd say we are in a Real Estate bubble and eventually home prices will likely fall.


This will go hand in hand with a rise in interest rates which means that lower home prices will still cost the same over the term of the loan and ultimately monthly payments will stay the same (as will rent).

This is basically Greenspan's theory on it and I'd have to agree. The price you pay monthly will remain as always a fairly fixed percentage of your income (~30% for most people), but as interest rate rise home prices will fall to compensate.

In my view this means two totally different things. First it's a good time to sell if you are planning to move to lower priced areas or retire. Second it's a good time to buy if you are buying a long term residence are a first time home buyer or are looking for potential rental properties.
posted by aaronscool at 9:18 PM on April 14, 2004

What is strange though if you drive 4 hours outside Baltimore to the rural areas and real estate is still affordable. There are towns in Appalachia in PA not 4 hours away that are nearly ghost towns abandoned. No one wants to live in these places they all want to live in Baltimore and DC and Philly and NY. Thats what driving it, the move from rural to urban. Plus immigrants move here and people born here stay here. The housing bubble is very localized in the urban hot markets. I read somewhere that western MD has fewer people today then it did in the 1800s.
posted by stbalbach at 9:19 PM on April 14, 2004

For that matter, look at house prices in still-urban places like Pittsburgh and Buffalo. You will weep.
posted by ROU_Xenophobe at 10:46 PM on April 14, 2004

stbalbach - This phenomenon happens in Japan too.
posted by troutfishing at 11:41 PM on April 14, 2004

Australian property has experienced a similar bubble in recent years. The difference in Australia is that there are huge tax advantages (for the wealthy) paid for by the poor. Negative gearing is banned in most countries since its really just a massive tax loophole that enables people to borrow large amounts then deliberately make losses so as to minimize their taxable income. Then they can later sell and get additional tax concessions on any capital gains. Rich tax breaks 'strip poor of $8bn' however, the politicians disagree.
posted by Meridian at 2:27 AM on April 15, 2004

Houses in the neighborhood where I live that were $90,000 6 years ago now go for $180,000 or more --- we're talking a rowhouse with less than 1000 square feet.

And see, the thing is, you have to ask yourself, "Is this home worth the asking price, or what people are paying for it?"

We bought our 50-year-old cape in 1999 and several neighboring houses have since been sold at prices that made my jaw drop. Knowing what I know about those properties - including the fact that at least one needed serious cosmetic and perhaps structural renovations - made me believe there truly is a bubble, for those homes are not empirically worth what was paid for them.

Of course, value is always in the eye of the beholder. But at some point, I've got to think the public at large stops and thinks, "Waitaminute, a row home that went for $90,000 in 1998 simply is not worth twice that now." And if that happens, that's when the bubble goes pop.
posted by kgasmart at 8:11 AM on April 15, 2004

And see, the thing is, you have to ask yourself, "Is this home worth the asking price, or what people are paying for it?"

And that is why I haven't bought a house.

The Baltimore real estate market is definitely on a bubble; the valuations of housing are completely out of whack. Some of it is spillover from Washington DC housing prices, some of it comes from other sources. But the prices are getting to the point where they're unsustainable, especially when you look at the economic conditions of the city. I would expect to hear a 'POP' in the not too distant future.

What is strange though if you drive 4 hours outside Baltimore to the rural areas and real estate is still affordable.

A friend of mine lives southeast of Pittsburgh, and yeah, the price differential is ridiculous.
posted by QuestionableSwami at 9:12 AM on April 15, 2004

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