Sunday, April 24, 2005

The Housing Bubble

Are we experiencing a housing bubble? That’s the million dollar question being asked by most homeowners today. Here is the evidence that we are in a massive housing bubble:

At first look, housing and real estate are performing spectacularly. Since 1980, the average home is up by 185 percent. In recent years, despite the recession, housing prices have risen by over 43 percent. To put that into perspective, in last 5 years, the average house-hold net worth inflated by $75,000. In California during 2002, the average house-hold soared by $3,000 per month!

Housing Bubble Chart

The rapidly rising housing prices are the main sign that we are in a massive housing bubble. Housing bubbles occur when housing prices overheat as they skyrocket, only to come crashing down for at least a decade to come.

What is Fueling the Housing Bubble?

This answer is the simplest: Mortgage rates are at a 40-year low. In 1982 mortgage rates were at a lofty 16 percent and have been dropping steadily to about 5 percent! When mortgage rates drop, monthly mortgage payments decrease as well. This decrease makes housing more affordable, which in turn triggers a bull market in housing prices.

Mortgage rates won’t stay low forever as this low rate environment can’t be maintained for much longer. When rates do rise, housing prices will fall as prospective home buyers will be discouraged by higher monthly mortgage payments.

A major sign that we are in a housing bubble is the fact that fewer people can afford homes. Housing prices have been rising at a vastly higher rate than incomes. Now more people are unable to afford the average home in their town. A housing bubble needs a steady stream of thirsty home buyers. If housing is significantly less affordable, then who is left to keep buying to prop up home values? No one! Overheated real estate prices are going to collapse plain and simple. This is just a real life example of supply and demand.

The Borrowing Binge

As interest rates have dropped, and housing prices soared, homeowners have found gold in home equity credit lines. These credit lines are a way for homeowners to borrow large sums of money backed by their home’s equity. Sort of like a credit card, but in the form of a house. Basically, these credit lines increase the amount of mortgage the homeowner owes.

To make matters worse, 51 percent of this borrowed money is being spent on home improvements and consumer items. Now you can see why $70,000+ luxury car market is booming!

Home equity has diminished significantly as we are consuming our free cash rather than paying off our mortgages. Simply stated, frivolous consumers are maxed out on credit. Since 1995 national mortgage debt has risen from $4 trillion to $7 trillion! In just 2002, $820 billion was borrowed! If this isn’t a sign of a housing bubble, than I don’t know what is.

The United States, as a whole, is in debt by $32 trillion, of which the majority was added in the borrowing binge of the 1990’s. The economy is so debt-ridden that we are now similar to a house of cards. It won’t take much to topple this ever inflating housing bubble.

The housing bubble will start to deflate when interest rates rise. Furthermore, even a slight downturn in our already feeble economy will cause an increase in mortgage delinquencies as consumers buckle from their debts. Of course when this happens, credit card defaults will also rise as will personal bankruptcies.

After the Housing Bubble Pops

After the housing bubble pops, prices will likely plummet for at least a decade, unfortunately. Too pessimistic? Consider this: After the 1989 Japanese housing bubble, housing prices tanked for 13 straight years! The Japanese housing bubble was a similar situation to what we are currently experiencing.

Even if the housing crash isn’t nearly as drastic, it could still take at least 9 years to recover. This is precisely what occurred after 1988 as the United States housing boom ended. National housing prices finally reached previous 1988 levels in 1997!

From what we have seen, it is inevitable that we are in a housing bubble that will end in an economic crisis. The economy always finds a way to punish excess.


At 5:16 PM, Blogger Jesse said...

That page is The Housing Bubble from my site Nice to see it get some publicity!

At 4:41 PM, Anonymous Anonymous said...

I can not wait to see housing crash. It has become unrealistic and just like the third world countries where 95% of people can not aford housing.

At 4:10 PM, Anonymous Anonymous said...

I live in Michigan, which recently beat out Alaska in unemployment in the US. We're #1 baby! The funny thing is people here are buying second homes and building McMansions like the economy is roaring.

People will soon realize they cannot live 2 steps ahead. Being upside down on a car loan is one thing, but on a half million dollar house...oh man. This crash will make the 90's Nasdaq bubble look like tiddlywinks.

At 10:29 PM, Anonymous Anonymous said...

I quite agree there is a housing bubble but what is going to pop it? The economy is looks like it will recover and interest rates probably won't reach the high levels seen years ago. Perhaps will just see a slow errosion in real value over twenty years. Less spectactular but equally brutal.

At 6:37 PM, Anonymous Anonymous said...

I quite agree there is a housing bubble but what is going to pop it?

I think that even if house prices flatten, that will be enough to cause an eventual pop. Here's why. Let's look at a typical rent-vs-own scenario where I live, Newport Beach, Orange County, California. I rent a nice 2-bedroom apartment near the ocean for $1400/month. There are identical units that are condos in the next building, priced in the $500k to $600k range. Let us consider just the cost of paying interest on a $500k mortgage. At 5.75%, that cost is $2400/month. If prices are not appreciating, then the owner is paying $1000 more per month than a renter in interest alone. Yes, this is tax deductible, but then there's property tax and condo fees which probably more or less negate that deduction. So if prices flatten out, then no sane renter would want to become an owner if it's going to cost nearly twice as much for the same dwelling. Demand therefore dries up. Pop goes the bubble.

At 8:35 AM, Anonymous Anonymous said...

Amen. In rural Northern California (and I'm not talking bay area) the same houses that are selling for $500,000 (equivalent of approximately $3,500 payment on a 30 yr fixed including prop tax) is renting for $1000-1200.

The same houses were selling for $275-300 only a year ago.

This isn't an individual example, this is all over the region now.

At 3:50 PM, Anonymous Anonymous said...

I live in Orange County, California. Rents for a two bedroom are $1800 to $2200. For a few hundred dollars more you can get a three bedroom townhouse. It's better to buy because you're building up equity.

Due to inflation in less than 10 years the cost of owning will be significantly less than the cost of renting. Remember rents always go up. As long as you have a 30 year mortgage your mortgage payments stay the same. Owning becomes cheaper and cheaper as time goes by.

I would never rent because it is not cost effective in the long run.

At 4:00 PM, Anonymous Anonymous said...

I think a rise in rates will lead to a small decline in housing prices but the existence of a bubble is unlikely. Those who are waiting for a bubble to burst before buying a home will more than like never have one. I've already made $300,000 from buying and selling three condos. I just recently bought my permanent home. People who fear a bubble have lost a significant amount of potential wealth.

In response to the article:

"Since 1980, the average home is up by 185 percent."

Incomes have also increased by 185% since 1980. It's called inflation.

"What is Fueling the Housing Bubble? This answer is the simplest: Mortgage rates are at a 40-year low."
Simple but not necessarily true. Mortgage rates could stay low for several years. Many analysts believe that the fed will be forced to start lowering interest rates again late this year because the economy has hit a soft patch. Other reasons for the rising prices:
1. Housing was actually undervalued due to the recession in the 90s. Housing prices have simply been catching up.
2. As manufacturing and agricultural jobs disappear more people are leaving manufacturing towns/cities and are moving to large metro areas such as Atlanta and Los Angeles
3. A huge influx of immigrants in the nineties. Many of these immigrants have just started to purchase their own homes
4. Loosening lending standards. A 20% down payment used to be almost a necessity to buy a home. Now that lending standards have been loosened people with good incomes who lack large down payments can buy a home. This includes single people who are buying homes at record rates
5. In large metro areas the supply of buildable land in drying up. In Southern California the supply of new housing is less than half what is needed due to land shortages and environmental regulations. In Phoenix and Las Vegas there is a lot of buildable land but that land is much further from the city centers.
6. Currently half of all Americans live within 50 miles of a coastline. This number is expected to double over the next fifty years.

"The housing bubble will start to deflate when interest rates rise."
Not necessarily. People with 30 year fixed rates will be unaffected. Many people who buy homes using ARMs don't actually intend the live in their homes very long, so why get a 30 year loan. Or they know that their incomes will have increased by the time their fixed period runs out. They can then refinance to a thirty year or simply pay the variable rate. Applications for 30 year mortgages are currently on the rise.

"Consider this: After the 1989 Japanese housing bubble, housing prices tanked for 13 straight years! The Japanese housing bubble was a similar situation to what we are currently experiencing."
Japan is in a long term recession. That is why housing fell so dramatically.

At 10:44 AM, Blogger Ed said...

A couple of points.

First off mortgage rates and the fed rates have very little to do with each other. Mortgage rates are based on bond yields.

Second I own a house in Las Vegas. I bought it for $300K in Sept '03. I bought it from the original owners who paid $189K in 2001. I am waiting until 2 years are up to get tax free cap gains, selling it and moving into a rental. There is no way this can keep up. A house appreciating
250% is just insane and the end must be near (I just hope sometime after Sept at least),

At 1:05 PM, Anonymous Anonymous said...

One Terrorist Attack in a major US City will bring down the housing market.

At 3:13 PM, Anonymous Anonymous said...

I bought my house in January 2002 for 117,500. Now in July 2005 it is worth 119,000.

I am falling futher and further behind in terms of being able to sell and move to a part of the country where values have risen.

Buying a home, for me, has been a HUGE MISTAKE.

At 10:49 AM, Anonymous Anonymous said...

My View:

Both myself and my wife make a pretty decent living, we have a child with little debt. Like most we felt pressure to get into the market because everyone said you had better before it was to late. I did and found myself with a 1100sq ft. box that needed work in an ok neighborhood with a $3100 mortgage. While we could afford it we had to consider more that just being homeowners. Like quality of life, savings, a huge questionable commitment, risk of buying in a Bubble or just at the wrong time, getting stuck in a little house that's really was only worth half of what we paid.

We sold the house a year and a half later, invested the cash, rent a 1500sq ft. 3bed condo for $1900 in a very nice part of Irvine. We take the $1200 we save and take a trip every month or save it.

I have watched several friends and co workers purchase homes in the last 2 years, some even refinancing more than once to take out cash. Now while some may be able to afford their new homes some of them are already feeling the pain and not one has a 30 fixed as the ARM option is the only way they could make it work (and it dont get better than that).

One friend even refinanced to help cover his monthly bills, "fool". Two others are selling because NOW they realize (reality) that under current market conditions home ownership is risky and is a huge financial commitment that has gotten out of hand. One slip, problem, broken car, lost job etc... and life as a whole could easily take a turn for the worst.

On another note: I have a couple of friends and family members who are Realtors or in lending. Like a lot of sales people they will tell you what they need to, just close the deal.

If your selling, you better hurry before the market takes a dive, dip, bust etc...

If you buying, then you better get in the market, now is a excellent time to buy, prices will only go up etc...

My realtor after getting to know him and once we were close to closing said he thought it was better to sell now than take a gamble and get stuck. Also, its a game he hates playing but he has bills that need to get paid.

Even good people will take advantage, "As much as I hate it, I would".

At 7:20 PM, Anonymous Anonymous said...

Greenspan has spoke...

Everytime there is an area where Americans can gain wealth the government steps is and stops it. For years in the mid 90's the stock market run up created wealth. Along came Greenspan....remember his comments over over exuberant investors... Now another area has created wealth. That area is real estate, and thousands if not millions of investors have created wealth. Now along comes Greenspan and his comments about bubbles and bursts that will come and his comments alone are enough to try to put the breaks on it.

The government does not want you to get rich. They hate wealthy americans, they're too independent, have too much freedom, can't be molded and can't be told what to do. What is worse, they don't vote right. There is nothing worse than a population that doesn't vote right, and history shows that. Remember when Lyndon B Johnson was voted in as VP along with John F. Kennedy as Pres. and Johnson did not, could not and failed to carry his home state of Texas. When Democrats and Kennedy asked Johnson "what the hell was going on not carrying his own home state" Johnson's comments were "well I'm going to stack hay in all those aerospace plants down there in Dallas and Houston as high as the cieling until those ass holes learn how to vote". What happened next is again history, LTV, General Dynamics, and the list goes on lost and did not get any government contracts for years. Thousands were thrown out of work for years or permanently because Johnson wanted payback ruthlessly.

Point is: government wants you broke to keep you manageable. Ignore Greenspan for once no one has ever lost a dime on real estate its the best investment you can make. No im not a broker, agent, investor or otherwise. Go buy your house and watch it appreciate and tell Greenspan to go pound salt especially before interest rates go up.

Stop listening to Greenspan and put the old man out to pasture.

At 4:33 AM, Anonymous Anonymous said...

looks like trouble for the UK housing market too.


At 7:50 PM, Anonymous Anonymous said...

Everything in this country seems to be becoming a bubble. Nothing is move to safer land (that is the housing market) from the stock market and that becomes a bubble too..these crashes are just driving Americans crazy.

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At 10:00 PM, Anonymous surfer808 said...

Everyone needs a home to live in in usa . people will just about do anything to pay for there monthly mortgage to live out of the rain ? not like a credit card payment for clothes or jewelery , ??

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