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Is There A Real Estate Bubble To Burst?

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With home values still below the peak seen in April 2007 it seems difficult to suggest that the price rises seen in the past year or so  might suggest a bubble.

“As home prices rise, we can’t just re-inflate another housing bubble,” said President Obama in August.

He explained that “housing prices generally don’t just keep on going up forever at the kind of pace it was going up. It was crazy. So what we want to do is something stable and steady.”

Well, yes, but consider that home values in the second quarter were 27.5 percent higher in Los Angeles when compared with 2012. Some other winning metro areas, according to the National Association of Realtors, included Las Vegas (31.4  percent), Miami (21.4), Phoenix (23.5 percent), San Francisco (27.8 percent),  and Sacramento (39.2 percent).

These kinds of numbers are neither slow nor steady. The national level of appreciation in the second quarter — 12.2 percent over the past year — is also  suspect.

But is it evidence of a bubble? Or something else?

In a bubble we usually think of massive and sudden prices declines. What we have here are specific areas — the areas beaten up most-badly during the foreclosure  meltdown — that have suddenly caught an amazing break.

The catch is that not every metro area has been so lucky. Some actually lost ground during the second quarter: Albuquerque (-1.5 percent), Binghamton, NY (-4.1 percent), Champaign-Urbana, IL (-3.6 percent), Columbia, MO (-2.5 percent),  Erie, PA (-5.7 percent), etc.

Income and Interest
Looking toward the future it seems impossible to believe that the annual price increases seen in the major foreclosure zones can continue. One reason is that incomes have been declining  since 1999 and thus there is less money to support bigger mortgages. A second reason is that interest levels — while still amazingly low by historic  standards — are higher than last year.

If the torrid pace of price increases seen in some areas during the past year cannot  continue it does not mean we will soon see falling home prices. The alternative is that we will see a pricing plateau or maybe even a return to gentle increases of 3 percent or 4 percent a year.

This could happen because while incomes are falling and interest rates are rising  there are other factors impacting home values. For instance, the FHA has just announced a new program for people who have lost their homes in foreclosures and short sales: under the back to work plan borrowers who lost their homes to tough times can now re-enter the housing market after just 12 months. The potential demand for such loans is enormous given that roughly seven million owners lost their homes during the past six or seven years.

Missing Households
Another factor which pressures home prices higher is that there is simply a lot of pent-up demand from people who have wanted to buy during the past few years but could not. Jed Kolko, the chief economist with Trulia,  argues that there are more that 2 million households which have not been formed  for the past few years, largely because of economic reasons.

Also consider that rental rates around the country are up, price increases which are  no doubt causing some tenants to wonder if ownership might now be a better option.

Lastly, we have Wall Street firms that investing billions of dollars in so-called REO-to-Rent programs. They are among the major buyers in foreclosure areas, but with prices rising will they invest in alternative markets where prices increases have been more modest?

Having the stable and steady market mentioned by the President is not a bad idea. Consider that with prices increases of 4 percent annually a home will double in value in 17.25 years under the rule of 69s. If 4 percent is more than the rate of inflation that means homeowners are generating additional buying power, another way of saying they have more wealthy.

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The ‘Inventory Shortage’ Myth


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