Wednesday, January 12, 2005

Buyers Have `Faith' Home Prices Outpace Stock Market

Bloomberg -- Forrest Maltzman, a college professor, sold stock in July to buy the house next door in Bethesda, Maryland, for $740,000. He plans to rent it to cover the mortgage, then sell for a profit in a few years.

In the hottest U.S. real estate markets, including the Washington area, where average prices rose 22 percent in the year ended Sept. 30, investors such as Maltzman expect better returns from real estate than from equities.

``I've been nervous about the stock market,'' says Maltzman, 41, who teaches politics at George Washington University. ``I have a lot of faith in real estate.''

About 30 percent of condominium buyers in Washington and San Francisco and 40 percent in South Florida are obtaining mortgages for investment purposes, says Gregory Leisch, chief executive of Delta Associates, a real-estate research firm. In South Florida, average home prices are rising by as much as 29 percent annually; in Southern California, 36 percent; and Las Vegas, 54 percent.

That's a sign the market may be overheating, says Stephen Roach, chief economist at Morgan Stanley in New York.

``The latest trends in house prices and savings are disturbing,'' Roach wrote in a Dec. 3 note to clients. ``They underscore the distinct possibility that America's asset economy is in the midst of yet another bubble-induced blow-off.''


An economic decline in these high-growth pockets, especially one accompanied by job losses, might cause investors to dump properties, undermining local housing values. With the U.S. personal savings rate at a record low of 0.2 percent and many people considering the equity in their homes as their nest egg, a decline in home prices may narrow retirement options.

An October report by Fannie Mae Chief Economist David Berson, using data from the San Francisco-based research firm LoanPerformance, said the proportion of people getting home mortgages for investment purposes nationwide rose to 9.2 percent in mid-2004 from 5.5 percent in mid-2003.

More of those people are using money for down payments that they once had invested in securities, says David Lereah, chief economist at the Chicago-based National Association of Realtors.

The enticement to buy houses and condos is strong in areas such as Washington, where the median home price has risen 69 percent to $362,400 in the past three years. During the same period, the benchmark Standard & Poor's 500 Index has risen 9.8 percent, including reinvested dividends.

Miami, West Palm

The nationwide increase in average home prices in the year ended Sept. 30 was 7.7 percent, according to the realtors' association. That leads most economists, including Federal Reserve Chairman Alan Greenspan, to conclude that there's no national housing ``bubble'' that might destabilize the economy.

Dean Baker, director of the Center for Economic and Policy Research in Washington, said today prices have gone up ``in enough regions that it can have a national economic impact.''

Fast-growth markets include Miami, where values in the last year have risen 23 percent; Fort Lauderdale, up 24 percent; West Palm Beach, up 29 percent; San Diego, 33 percent; and Los Angeles, 24 percent, according to the realtors' association.

``There's been yield chasing, where investors that normally invest in Treasuries and corporate products chase real estate for higher yields,'' says John Benjamin, a professor of finance and real estate at American University's Kogod School of Business in Washington.

Some Fed officials are concerned. The minutes to the central bank's Dec. 14 meeting say that low interest rates may be encouraging ``excessive risk-taking.'' They cited ``anecdotal evidence that speculative demands were becoming apparent in the markets for single-family homes and condominiums.''

`Like Buying a Bond'

Nik Shah, 31, a mergers and acquisitions consultant, owns $2 million worth of condominiums that he rents in Washington's Dupont Circle, Foggy Bottom and Georgetown neighborhoods and says the value of each has doubled in the last two years.

``It's like buying a bond,'' Shah says. ``I bought it and I'm getting a coupon payment and the value is appreciating.''

Now, Shah says he's stopped buying because the market may have overheated.

``When the stock market was flying high, only 10 percent of condo buyers were investors,'' says Delta's Leisch from his office in Arlington, Virginia. He estimates that 30 percent of Washington condos now go to buyers seeking investment gains.

While some investors are buying second homes in their local areas, others are purchasing in vacation properties. A record 445,000 vacation homes were sold in 2003, a 24 percent gain from 2001, the realtors' association says. The gain is largely driven by baby boomers reaching their peak earning years and looking toward retirement.

Vacation Homes

Prices for vacation homes in resort and coastal areas are likely to rise at twice the rate of the overall residential market, says Lereah, the association's economist.

An association survey to be published in February will probably show that second-home sales reached a record in 2004.

``There's a sense that the investment component has risen,'' says Walter Molony, a National Association of Realtors spokesman. ``The appreciation has been very strong, and it's been demonstrated to be a good investment.''

Robert Montagne, 41, CEO of Walnut Street Development Construction in Fairfax, Virginia, estimates that 30 percent to 40 percent of the buyers of the Clarendon 1021 condominium project in nearby Arlington are investors.

``Investors bring liquidity, and they create a buzz around the place,'' he says.

Anti-Speculation Clause

Other builders aren't so sure.

Andrew Viola, president of Bush Cos., which is erecting a large condominium building directly across the street from Clarendon 1021, says he worries that investors may be making the market unsteady. He makes buyers agree not to sell for profit within two years.

``We don't want a bunch of investors in our units,'' Viola says. ``If these people are contracting in multiple buildings, and they're relying on taking the profits from one settlement to pay for the other settlement, and there was an adjustment in the market, all of a sudden they don't have the funds.''

Huntingdon Valley, Pennsylvania-based Toll Brothers Inc., the largest U.S. builder of luxury homes, has similar anti-speculation clauses for buyers in hot markets, spokeswoman Keira McCarron says.

The precise extent to which speculation is pushing up housing values is hard to know because comprehensive data collected at regular intervals doesn't exist, say Fed officials and private economists.


``We measure who is buying and who is selling and the price,'' Fed Governor Edward Gramlich, 65, said today in Washington. ``To get into their intentions -- are they doing this speculatively or because they've got to have a house to live in, is very difficult.

``I'm not saying speculation is zero, but it's a hard issue to get a handle on.''

Housing ``does not qualify for special monetary treatment at this point, but we're going to keep an eye on it,'' Gramlich said.

The data from Delta Associates was limited to condominium buyers in specific markets. LoanPerformance collects information about mortgage originations in which applicants say they are buying a home for investment purposes. Still, investors may falsify their intentions because mortgage interest rates and down- payment requirements are higher on investment properties, so the numbers may undercount actual investment levels.

``I still see in some very selective markets what looks like very unusual things going on in residential real estate,'' says Atlanta Fed President Jack Guynn. He says low interest rates discourage sound allocation of capital. ``That's another reason for us to get rates to a more normal kind of setting.''

`Unusual Things'

Economists including the Fed's Greenspan say job and wage growth, and interest rates, are what underpins the nationwide increase in home values.

``It would take a large and historically most unusual fall in home prices to wipe out a significant part of home equity,'' Greenspan said in an Oct. 19 speech to bankers meeting in Washington. ``Many of those who purchased their residence more than a year ago have equity buffers in their homes adequate to withstand any price decline other than a very deep one.''

The Federal Reserve raised the benchmark overnight bank lending rate five times last year to 2.25 percent from a four- decade low of 1 percent. The average U.S. rate for a 30-year mortgage was 5.85 percent in 2004, the second-lowest in 38 years, according to Washington-based Fannie Mae, the largest mortgage financier.

Scott Mednick, 42, who for eight years has bought and sold property in Orange County, California, south of Los Angeles, says he's seeing the beginnings of a slowdown.

`Holding Off'

After spending six weeks trying to sell a two-bedroom, $450,000 condominium in Mission Viejo, Mednick offered to throw in a $2,000 flat-screen television set.

``That absolutely did nothing,'' he says. ``In a great market it would fly off the shelves, but now people are just holding off.''

The last time a U.S. housing bubble burst was in the early 1990s when speculative building and a recession beginning in July 1990 combined with what some economists and builders call ``loose'' lending practices. It led to real-estate slumps in California and parts of the East Coast. In New England, housing prices appreciated more than 16 percent from 1983 to 1987, then fell 7.7 percent in 1990 and continued to decline for three of the next four years.

Home prices rose nationwide more than 6 percent a year from 1985 to 1989, then rose 0.2 percent in 1990.

Lereah says job loss was the major cause of past collapses in real-estate values.

In Las Vegas, Bill Guerra, 42, is taking advantage of the boom. A former registered nurse, he now locates properties whose sellers are short on cash, are close to foreclosure or need to move out quickly. He then shares the profit on the final sale with a builder who rehabilitates the home.

Guerra says competition has picked up in the last 20 months as more people look for investment properties.

``Real estate has always been a passion of mine,'' he says. ``I just love the stuff, and money was certainly a motivator.''


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