Sunday, September 19, 2004

Talk of Housing Bubble Has Fears Rising, but in Reality It's a Lot of Hot Air

By James Flanigan, Los Angeles Times

Bubble? Baloney.

Housing sales are slowing in most of Southern California, and home prices, after a ferocious run-up, are beginning to level off. That has prompted some to warn, as Fortune magazine does on the cover of its latest issue, that "the bubble is going to pop."

Yet the facts belie the fears.

Plain and simple, there is no housing bubble — not in Southern California or anywhere else in the United States, for that matter. The market in Los Angeles, Orange and San Diego counties may be throttling back a bit. But that's hardly a cause for alarm.

"Nothing extraordinary will happen in the business of buying and selling houses," says Raphael Bostic of USC's Lusk Center for Real Estate, one of the more sober analysts around. Home sales and prices don't move dramatically — much less pop, Bostic explains — unless a major downdraft occurs in the larger economy.

For example, the aerospace industry collapse of the early 1990s sent Southern California house prices down 25% on average; the dot-com collapse in Silicon Valley of three years ago has pared average home prices in the Bay Area by more than 20%.

Happily, though, no regional or national recession is looming right now. The recovery has been balky and job creation weak, but the economy is still growing at a reasonable pace overall.

Even more important are the market fundamentals, which augur for continued strength in home prices: Demand for new houses continues to grow in the face of tight supply.

Demographics are one big driver.

"Immigrants and their families are avid home buyers," notes Bruce Karatz, chairman of KB Home, the Los Angeles-based home-building giant. "When they've been here a few years, they are in the market."

Newcomers to the U.S. are boosting the nation's population by 1.3 million annually, according to the Census Bureau, bringing the overall increase to 2.8 million. Along with easier credit, the trend helps explain why the housing market saw 7 million new and existing homes sold last year, up from 3 million 25 years ago.

And the numbers are only going to go higher in the next decade. The Harvard Joint Center for Housing Studies projects that the supply of homes in the U.S. will have to rise by 10% annually through 2015 simply to accommodate the number of new households being formed.

Meanwhile, single women also have added to housing demand in the last decade — a phenomenon sure to continue. Over the next 10 years, retiring baby boomers also will swell the market for second homes.

And then there's the supply side of the equation.

Burned too many times before, home builders have been wary of putting up new units on spec. Regulatory restrictions on the development of homes also have contributed to scarcity in many areas. This is true not only in persnickety California but in other parts of the country as well.

"It's as hard to get building permits in Maryland as in Southern California," says R. Chad Dreier, chairman of Ryland Group Inc., a nationwide home builder based in Calabasas.

Another factor: The need for developers to hold costly options on land for years and years has squeezed smaller players out of the market, further cutting into supply. Today, large home-building companies increasingly dominate the scene because they can manage the financing required for lengthy projects. But they also tightly control the number of jobs they take on.

"We pick our spots carefully," says Richard Dugas Jr., president of Pulte Homes Inc., a Bloomfield Hills, Mich.-based builder with $9 billion in annual revenue.

The result has been a dearth of homes in many areas — and, in turn, a surge in prices: up 23% last year in Baltimore, for example; up more than 20% all over Florida; up 52% in Las Vegas; up 25% in Orange County.

Soaring prices, however, don't equate to a bubble, because no sudden rush in new construction is in the offing. Supply and demand are likely to remain out of whack for a long time.

To be sure, the heavy debt load being carried by American consumers also is a cause of bubble talk.

How can buyers afford their mortgages, economists ask, when wage levels are not rising in America? The statistics seem ominous: Residential mortgage debt has ballooned to $8 trillion today from $5.6 trillion in 2000.

But there is an offsetting dynamic: Mortgage rates are at a 28-year low. As a result, the monthly carrying costs of mortgage debt is 18% of household income on average — compared with an average of 22% in the 1990s and 30% in the late 1980s.

Adjustable-rate mortgages may make some owners vulnerable. But even then, USC's Bostic says, "it's a matter of timing more than finance."

Most adjustable-rate mortgages have terms of three to five years, he points out. "So we would have to see what a homeowner's situation is years from now when the mortgage comes up for renewal."

In any event, the outlook for interest rates is for gradual increases, not sudden jumps.

Veteran interest rate predictor Albert M. Wojnilower foresees a rise in long-term rates to a level that suggests mortgage rates of 7% to 7.5% a year from now, a level that might restrain the housing market but wouldn't send it swooning.

So let the experts keep offering up dire predictions about a bubble. They are, well, bound to blow it.