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Is Real Estate Headed For A Fall?

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There are various people who think that both real estate and stocks are vastly overpriced. Last week, for example, the stock market closed with the S&P 500 over 1,800 for the first time while the Dow topped 16,000. How much higher can these measures go — or must they fall?

Meanwhile with housing we have seen several interesting trends:

First, existing home prices in October were 12.8 percent higher than a year ago, according to the National Association of Realtors. However, in the coming year NAR is predicting that prices will increase just 6 percent in 2014. In other words, price appreciation will tumble by half.

Second, interest rates are expected to rise. NAR predicts that mortgage rates will reach 5.4 percent by the end of 2014. The Mortgage Bankers Association predicts that 2014 rates will increase to 5 percent while in  2015 rates could hit 5.5 percent.

Slowing price appreciation is hardly a surprise in an environment with rising interest levels. But are we headed for a real estate bubble?

A Bloomberg Global Poll says that 31 percent of its subscribers see U.S. housing prices “approaching or at excessive levels.”

That Bloomberg poll sounds fairly dire, but the same survey also shows that respondents think the situation is far worse in China, where 73 percent see a bubble and London where 60 percent believe real estate values will soon tumble. 

Another bit of context comes from FHFA, the Federal Housing Finance Agency. It says that home values as of August were 8.5 percent  higher than a year ago — but that home values remain in a trough, 9.4 percent lower than the peak reached in April 2007.

What are we to think of these conflicting numbers?

I would argue that none of the numbers seen here are surprising — or evidence of a coming bubble. If anything, they should be seen as a source of relief.

Consider interest rates. As of this writing they're around 4.3 percent. That's "up" from 2012 but — again — context counts. In 2012, we had the lowest rates seen in 65 years. Did anyone really think mortgage rates would go lower?

And about those housing prices. Yes, it looks like appreciation levels will fall by  a half but — more context — the prediction is for rising prices. Indeed, 6 percent appreciation is likely to be far above the rate of inflation which means that real estate ownership will create real wealth in 2014.

But not everywhere. Many urban California metro areas have seen home values rise 20 percent or better during the past year, according to NAR. In the third quarter, San Francisco was up 24.1 percent, Los Angles rose 26.2 percent and in San Diego values soared 23 percent. Can such appreciation continue or will there be a retreat, especially if interest rates really do  increase?

“With mortgage rates rising,” said Frank Nothaft, Freddie Mac vice president and chief economist. “We’re also going to see the  home-sales gains as well as the impressive house price growth begin to moderate to more sustainable levels.”

Stagnant Incomes
It's very difficult to understand why prices have appreciated so much during the  past year. Yes, we have a growing population and there is surely pent-up demand  but look at household incomes: They're not just stagnant, they're falling. According to the Census Bureau, 2011 incomes were 8.9 percent lower than in 1999, a year when the typical home sold for $138,000.

How do people pay for homes which now cost on average $199,500 when incomes are  effectively lower than12 years ago? Part of the answer is far lower interest levels — roughly 4.3 percent versus 7.44 percent in 1999, a huge reduction.

The catch is that the wonders of low rates only go so far. The genie in the bottle only grants so many wishes and it looks like 2014 will be a very calm year. If  we're lucky enough to see only moderate price growth, we'll have much to celebrate. Hopefully, the only bubbles we'll find in 2014 will be when corks fly and champagne flows.

Happy  New Year everyone.


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