Sunday, December 26, 2004

Are we inside a bubble, looking out?

Herald Tribune

Just as dot-com stocks dominated cocktail party chatter in 1999, the ever-rising market for real estate is now on everyone's minds.

The Southwest Florida real estate boom is not occurring in isolation. It is part of a state, national and even global move away from paper and toward hard assets, particularly property.

At what point do you say that rising real estate prices constitute a bubble, with the corresponding implication that the bubble might burst?

John P. Calverley, chief economist and strategist for American Express Bank, studied the subject and has just published a book titled "Bubbles and How to Survive Them." Calverley examines the Great Depression, Japan's bubble in the 1980s, and the Internet stock bubble of the past few years. Moving into the present, he discusses what he sees as a global bubble in housing.

Business writer Michael Pollick interviewed Calverley by phone at his London offices, seeking his informed view of where we're at and what to watch out for.

Q How do you know if you're in a real estate bubble?

A When you talk to academics about bubbles, they struggle. There are many factors, and it is difficult to make the list work for all bubbles. The way I try to do it, is I've got a check list in the book.

Seeing lots of condo development is one of the clear signs. Condos always look profitable to the developer, because you are putting a lot of residences on one site. You end up with overbuilding because it turns out that many of the buyers are either purely speculating or buying for investment. There may not be enough final users.

Q So what if there aren't enough final users?

A Well, then, you see the rents crash and a lot of vacancy in the building. Then some people think it is time to sell, and that tends to pull down prices. And it is much more likely to be bought as an investment, for renting out, compared to single-family homes.

Condos also are attractive for speculation, if you can buy off-plan, before the building is completed, and you only have to put down a deposit. As the building goes up, you can double your deposit money without even putting up the whole amount.

Q Understanding that you haven't made a study of Sarasota housing, how do you characterize the housing market in the United States, or Florida in general.

A The latest data show a 13 percent increase in house prices for the country as a whole from a year earlier. Sarasota-Bradenton-Venice shows a 19.7 percent increase over the last year. That is the increase in the average price for the nine months through September. You are by no means the fastest-growing. The fastest was in Las Vegas. Over the last year, they showed a 41.7 percent increase.

In the U.S. as whole, I would say we are in the early to middle stages of a bubble, with many areas on the coast already at an advanced stage. My country, the U.K., and Australia, Spain, Ireland and Holland are the most advanced.

In London you can easily pay a million dollars for a 1,200-square-foot apartment. The pound is very strong at the moment compared with the dollar, so that makes it look worse. I live in a 1,200-square-foot apartment, which I rent. I think the owner would probably think it is worth 650,000 pounds, which is close to $1.1 million.

Q How do you know when the bubble is going to burst? Does it always burst? Isn't it possible that prices will just plateau at a higher level?

A I don't think there is any particular level of prices where you can say, it is going to fall from there. When you've got very high prices, I think they will correct downward at some point, but they could easily go 25 percent higher first. Bubbles can just get inflated far bigger than you ever expect.

Q If someone in Sarasota is sitting there in their home with a 100 percent, 200 percent, 500 percent paper profit, what should they take away from this interview?

A I think the main take- away is that prices could fall significantly at some point.

Q If we are in the bubble, when should we expect it to end?

A My view is that property prices in the U.S. probably are going to continue to rise, for some months, perhaps another year or so, because I am quite positive on the U.S. economy. And I think interest rates, mortgage rates, will only rise gradually.

Q If someone thinks his investment exists within a bubble, how can he protect himself?

A Ultimately, it is very difficult to hold onto the property and protect yourself. It isn't easy to hedge against property prices falling. The only thing you can do is reduce your exposure. You can downscale to a cheaper property, either smaller or in a less- expensive area.

Q Those who insist our rising prices are not dangerous point to the fact that prices are much higher elsewhere in the U.S. How do you respond?

A That is one of the factors that is driving the Florida market, is that people have made a lot of money on their property in the Northeast. It makes it easier for them to remortgage, and buy a second home.

It also makes them more comfortable with a large dollar figure. It's easier psychologically to buy a half-a-million-dollar home in Florida if your home in New York has gone up from $1 million to $2 million.

That brings up another psychological factor I point to in my book that occurs during bubbles, which is called anchoring. Anchoring is where people look at the existing prices, and they treat that as an anchor for where prices should be. It's OK, as long as prices aren't wildly out of line with fundamentals.

Q What are the fundamentals?

A I would look at rental yields. I look at it as the annual rental over the value.

So down there in Florida, say you have a house selling for $300,000, but if you rented it, you'd only get $900 a month. That's $11,000 a year. So you're getting 31/2 to 4 percent yield if it is a $300,000 property. That is very low. I say in the book that a rental yield of six to 10 percent is a more reasonable level.

Another fundamental approach, you can look at it in relationship of prices to people's income. But in a resort area, I think that is less relevant, because many people are buying second homes or vacation homes.

Within a bubble environment, what are the price characteristics of resort property in general?

A I think it tends to go up later, it tends to follow, because it is the money being made elsewhere that gets transferred down. I think it is also liable to be particularly volatile, to overshoot on the upside and to fall more on the downside.

Q What about the scenario that the bubble could burst up North, resounding in Florida?

A The answer is yes. The vulnerability would be if you had a crash in the Northeast, the people there would be less likely to buy a second home or a retirement home in Sarasota. What is driving Sarasota prices is people coming in from outside and buying, and simultaneously, and then people from Sarasota seeking to upgrade, or speculating on higher prices.

Q Those who say prices will never decline here, only plateau or grow less rapidly, point to the fact that Sarasota is not just any resort, that it has grown into a more desirable location in a permanent way.

A Places do get re-rated; places do become fashionable and outperform. I think the issue really is, how far it might fall in a weak market nationwide.

If prices in Florida fall because of a weak property market generally, then maybe Sarasota is going to fall less than other places, if Sarasota has become more fashionable than it used to be.

So that is a positive factor for your local readers. But that doesn't mean it won't fall in a bad market.


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