| It seems everyone is discussing the possibility of a
housing bubble these days, even Alan Greenspan. What is clear is that
certain markets in the US are showing signs of being overpriced when
compared to historic ratios between housing prices and income levels.
These markets (such as Boston and San Francisco) are showing signs of
unsustainable house prices by comparison to these statistical measures.
For reasons nobody seems to be able to provide, interest rates remain
at historic lows (see left), fuelling demand for housing and making more
expensive housing more affordable even at increased prices.
For people already in the housing market, moving from one home to
another in the same area is a matter of moving equity; cashing in on the
new-found value in their existing home and investing this equity into a
new home, perhaps with a slightly higher mortgage (often with lower
monthly payments). Inflated house prices have no impact to these people
since they are swapping equity.
What normally makes these inflated markets hard to sustain is the
availability of entry-level housing. With entry-level housing at $300,000
and above in the suburbs, a first-time-buyer needs to find $60,000 to put
down on a home to avoid paying PMI (private mortgage insurance). Since
there are very few first-time-buyers with this kind of equity in the bank,
lenders have been getting creative in offering 100% financing, often
avoiding PMI premiums by selling two loans (the first loan is a
traditional mortgage, often interest only, for 80% of the value; the
second is something like a Home Equity line at a higher rate of interest
to cover the 20%). Some lenders are even having buyers roll their closing
costs into the loans by having them pay more than asking price for the
home and having the seller kick-back the closing costs from the additional
monies (e.g. a $300,000 home sells for $305,000 with 100% financing and
the seller pays $5,000 in closing costs. The seller receives the asking
price of $300,000 and the buyer has a mortgage for $305,000).
While these practices are working in the present market, when interest
rates rise as they surely will, it will be these entry-level-homes that
come onto the market first (as first-time-buyers get into difficulty
making their loan repayments). Markets will see an increase in the number
of foreclosures as owners simply walk away from their homes because they
have no equity in the home. This could impact prices throughout a region
by pulling prices lower based upon comparable sales.
Another factor to consider is the number of investors in a given
market. The national survey by the Board of Realtors shows roughly 30% of
homes are purchased as investments. Since some markets make for better
investments than others because homes cost less, there are sure to be
national variations where a higher percentage of homes are investments
(Florida for example). In a declining housing market, a significant
portion of these investors may be tempted to liquidate their assets,
thereby driving prices down further. Note: The smart investor will
recognize house prices have historically always come back stronger and
take the opportunity to buy in the declining market and hold for the long
term.
While these combined factors suggest there is a strong likelihood of
regional price corrections when interest rates rise, there is another
factor to consider: Housing is a function of supply and demand. Supply is
not balanced throughout the country since available land is scarcer in
some locations (e.g. older cities). Since most value is in land and not
buildings in these areas, when land prices rise due to scarcity, the
property value has to rise with it. (Which is why savvy investors have
been buying old cottages near major cities and tearing them down to build
new homes).
Taking the scarcity of land into account might lead you to conclude
there is less likely to be a decline in prices in areas where buildable
land is nearly exhausted and more likely to be a decline in areas where
land is more freely available for new construction.
Factor in the demographics of the baby-boom generation and consider how
they will be paying for a long retirement. What will they be doing with
homes in areas where they no longer want to live? We must not
underestimate the impact boomers will have in every housing market in the
US over the next twenty years.
Above all it will pay to remember that the housing market is
predictably slow to react. Prices shown for sales today are based on deals
that were agreed upon two, three or four months ago. As prices drop (or
rise), the changes are reflected in settled prices several months later.
Appraisers use these settled prices to put a value on future sales, so any
decline in prices takes several months to work through the system, and all
of it is visible to Realtors working in the market on a full-time basis.
The changes are predictable and slow by comparison to the stock market.
Bubbles burst with a pop! The housing market is more like a growing sponge
than a bubble; sometimes it is squeezed and water (money) drops out
slowly, at other times is soaks up water (money) and expands. Sponges
don't pop.
In conclusion, housing remains a strong investment option since land is
finite and people need a place to live. As long as the population
continues to grow, demand will continue to push prices in an upward
direction over the long-term. Plus, there is no other place where you can
leverage other people's money quite so easily and predictably over the
long-term. If all else fails, buy low, hold and sell
high! |
