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====Popularity of home investing and flipping in the media====
====Popularity of home investing and flipping in the media====


In late [[2005]] and into [[2006]], there are an abundance of television programs promoting real estate investment and [[flipping]] [http://www.washingtonpost.com/wp-dyn/content/article/2005/12/27/AR2005122701018_pf.html]. These include:
In late [[2005]] and into [[2006]], there are an abundance of television programs promoting real estate investment and [[flipping]] [http://www.washingtonpost.com/wp-dyn/content/article/2005/12/27/AR2005122701018_pf.html]. These include
*[[HGTV]]'s "[[House Hunters]]"
*[[HGTV]]'s "[[House Hunters]]"
*[[HGTV]]'s "[[What You Get for the Money]]"
*[[HGTV]]'s "[[What You Get for the Money]]"

Revision as of 11:37, 17 April 2006

This article is about the housing bubble in the United States. For the general phenomenon of housing bubbles, see real estate bubble.
File:Time Magazine June 13 2005 Cover.jpg
Home $weet Home: cover of the June 13, 2005 issue of Time Magazine.

The United States housing bubble refers to a belief that there is an economic bubble in real estate in the United States. This follows the stock market bubble in the 1990s which was called, among other things, the dot-com bubble. A real estate bubble or property bubble (or housing bubble for residential markets) is a type of economic bubble that occurs periodically in local or global real estate markets. It is characterized by rapid increases in the valuations of real property such as housing until they reach unsustainable levels relative to incomes and other economic indicators. This in turn is followed by decreases that can result in many owners holding negative equity (a mortgage debt higher than the value of the property). Just like any type of economic bubble, it is difficult to identify except in hindsight, after the crash.

There are several factors believed to explain the U.S. housing bubble. The Economist magazine said that "the worldwide rise in house prices is the biggest bubble in history" [2], so any explanation must consider global causes as well as those specific to the United States. Former Federal Reserve Chairman Alan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) … it's hard not to see that there are a lot of local bubbles." President Bush said of the U.S. housing boom in early 2006 "If houses get too expensive, people will stop buying them … Economies should cycle" [3].

Bubbles may only be positively identified by some in hindsight, after a market correction, and there is debate during the rise in prices about whether this is caused by a mania or sustainable economic reasons such as larger demand due to increased population and liquidity, and limited supply.

Explanations for the existence of a U.S. housing bubble

File:Barrons shiller 06-20-2005.gif
Robert Shiller's plot of U.S. home prices, population, building costs, and bond yields (from Irrational Exuberance, 2d ed. Princeton University Press). Shiller shows that inflation adjusted U.S. home prices increased 0.4% per year from 1890–2004, and 0.7% per year from 1940–2004, whereas U.S. census data from 1940–2004 shows that the self-assessed value increased 2% per year.

Mania for home ownership

Americans' love of their homes is widely known and acknowledged; however, many believe that enthusiasm for home ownership is currently very high even by American standards. Many have commented anecdotally on this phenomenon, as evidenced by the cover of the 13 June 2005 issue of Time Magazine (seen above). This newfound enthusiasm would be consistent explained by other factors and beliefs:

Widespread belief that home prices never fall

This folk wisdom is often heard, and appears to be encouraged by the real estate industry. However, it is manifestly untrue, as evidenced by the relatively recent price history of housing in locations such as New York, Los Angeles, Boston, Japan, Vancouver, Hong Kong, and myriad more.

Widespread belief that housing is a sound investment

For some this has been undoubtedly true, and for others, not. In fact, Robert Shiller shows that over long periods, inflation adjusted U.S. home prices increased 0.4% per year from 1890–2004, and 0.7% per year from 1940–2004. Shiller also showed comparable results for housing prices on a single street in Amsterdam (the site of the fabled tulip mania, and where the housing supply is notably limited) over a 350 year period. Such meager returns are dwarfed by investments in the stock and bond markets (but houses at least can be lived in, while stocks and bonds are only paper). If historic trends hold, it is reasonable to expect home prices to only slightly beat inflation over the long term. Furthermore, one way to assess the quality of any investment is to compute its price-to-earnings (P/E) ratio, which for houses can be defined as the price of the house divided by the potential annual rental income, minus expenses including maintenance and taxes on the rental income. For many locations, this computation yields a P/E ratio of about 30–40, which is considered high or very high for the stock market. Just before the dot-com crash, the P/E ratio of the S&P 500 was 45.

The "ownership society" versus renting

Though he did not specifically use it in this way, President George W. Bush's 2004 reelection campaign slogan "the ownership society" reflects the strong preference of Americans to own the homes they live in, as opposed to renting them.

Popularity of home investing and flipping in the media

In late 2005 and into 2006, there are an abundance of television programs promoting real estate investment and flipping [4]. These include

In addition to the numerous television shows, book stores in cities throughout the United States could be seen showing large displays of books touting real-estate investment, such as NAR chief economist David Lereah's book Are You Missing the Real Estate Boom?: Why Home Values and Other Real Estate Investments Will Climb Through The End of The Decade—And How to Profit From Them published in February 2005. One year later in February 2006, Lereah retitled his book Why the Real Estate Boom Will Not Bust—And How You Can Profit from It.

File:Lereah BookCover 2005.jpg
NAR chief economist David Lereah's book in February 2005.
File:LereahNotBust.jpg
NAR chief economist David Lereah's book in February 2006.

Speculative purchases of homes

As median home prices began to rise dramatically in 2000–2001 following the fall in interest rates, speculative purchases of homes also increased. Fortune magazine's article on housing speculation in 2005 said,

"America was awash in a stark, raving frenzy that looked every bit as crazy as dot-com stocks." [5]

In a 2006 interview in BusinessWeek magazine, Yale economist Robert Shiller said of the impact of speculators on long term valuations,

"I worry about a big fall because prices today are being supported by a speculative fever" [6],

and NAR chief economist David Lereah said in 2005 that

"[t]here's a speculative element in home buying now."

Speculation in some local markets has been greater than others, and any correction in valuations is expected to be strongly related to the percentage amount of speculative purchases. In the same BusinessWeek interview, Angelo Mozilo, CEO of mortgage lender Countrywide Financial, said

"in areas where you have had heavy speculation, you could have 30% [home price declines]. … A year or a year and half from now, you will have seen a slow deterioration of home values and a substantial deterioration in those areas where there has been speculative excess.”

The chief economist for the National Association of Home Builders, David Seiders, said that California, Las Vegas, Florida and the Washington, D.C., area “have the largest potential for a price slowdown” because the rising prices in those markets were fed by speculators who bought homes intending to “flip” or sell them for a quick profit [7].

Crash of the dot-com bubble

It has been said that the dot-com crash in 2000 and the subsequent 70% (or so) drop of the NASDAQ composite index resulted in many people taking their money out of the stock market and investing in what is believed by many to be a more reliable investment: real estate.

Historically low interest rates

Another important consequence of the dot-com crash and the subsequent 2001–2002 recession was that the Federal Reserve dropped short-term interest rates to historically low levels, from about 6.5% to just 1%. The interest rate on 30-year fixed-rate mortgages fell 2 percentage points (from about 7.5% to about 5.5%). The interest rate on one-year adjustable rate mortgages (1/1 ARMs) fell 3 percentage points (from about 7% to about 4%). A drop in mortgage interest rates reduces the cost of borrowing and should logically result in an increase in prices in a market where most people borrow money to purchase a home (for instance, in the United States). If one assumes that the housing market is efficient, the expected change in housing prices (relative to interest rates) can be computed mathematically. The calculation below will show that a 1 percentage point change in interest rates would theoretically affect home prices by about 10% (given current rates on fixed-rate mortgages). This represents a 10-to-1 multiplier between percentage-point changes in interest rates and percentage change in home prices.

The computation proceeds by designating affordability (the monthly mortage payment) constant, and differentiating the equation for monthly payments

with respect to the interest rate r, then solving for the change in Principal. Using the approximation (K → ∞, and e = 2.718… is the base of the natural logarithm) for continuously compounded interest, this results in the approximate equation

For interest-only mortgages, the change in principal yielding the same monthly payment is

which yields about a 16% change in principal for a 1% change in interest rates at current rates. Therefore, the 2% drop in long-term interest rates can account for about a 10 × 2% = 20% rise in home prices if every buyer is using a fixed-rate mortgage (FRM), or about 16 × 3% ≈ 50% if every buyer is using an adjustable rate mortgage (ARM) whose interest rates dropped 3%. Robert Shiller shows that the inflation adjusted U.S. home price increase has been about 45% during this period, an increase in valuations that is approximately consistent with most buyers financing their purchases using ARMs. In areas of the United States believed to have a housing bubble, price increases have far exceeded the 50% that might be explained by the cost of borrowing using ARMs. When interest rates rise, a reasonable question is how much house prices will fall, and what effect this will have those holding negative equity, as well as the U.S. economy in general. Shiller does compare interest rates and overall U.S. home prices over the period 1890–2004 and concludes that interest rates do not explain historic trends for the country. The salient question is if interest rates are a determining factor in specific markets where there is high sensitivity to housing affordability.

Exotic interest-only and adjustable rate mortgages

The recent use of the exotic adjustable-rate and interest-only mortgages to finance home purchases described above have raised concerns about the quality of these loans should interest rates rise again. Factors that could contribute to rising rates are the U.S. national debt, inflationary pressure caused by such factors as increased fuel and housing costs, and changes in foreign investments in the U.S. economy.

Evaluations of the U.S. housing bubble

File:Barrons BubblesNewHome 20050620.gif
Plot of inflation-adjusted home home price appreciation in several U.S. cities, 1990–2005.
Inflation-adjusted housing prices in Japan (1980–2005) compared to home price appreciation the the United States, Britain, and Australia (1995–2005).
  • "At a minimum, there's a little froth [in the U.S. housing market]" … "It's hard not to see that there are a lot of local bubbles." —Federal Reserve Chairman Alan Greenspan [8], May 2005.
  • "Froth in housing markets may be spilling over into mortgage markets." —Federal Reserve Chairman Alan Greenspan [9], September 2005.
  • "[T]he American housing boom is now the mother of all bubbles—in sheer volume, if not in degrees of speculative madness." —The Telegraph (UK) [10], 23 March 2006.
  • President George W. Bush was asked about the housing boom's impact on the ability of the questioner's children to purchase a home. The President answered "… If houses get too expensive, people will stop buying them, which will cause people to adjust their spending habits. … Let the market function properly. I guarantee that your kind of question has been asked throughout the history of homebuilding—you know, prices for my homes are getting bid up so high that I'm afraid I'm not going to have any consumers—or my kid—and yet, things cycle. That's just the way it works. Economies should cycle." —President George W. Bush [11], 19 January 2006.
  • "Certainly at the high end of the real estate market in some areas, you've seen extraordinary movement. … People go crazy in economics periodically, in all kinds of ways … when you get prices increasing faster than the underlying costs, sometimes there can be pretty serious consequences." —Warren Buffett, 2005 [12].
  • "Soros said he believed the U.S. housing bubble, a major factor behind strong U.S. consumption, had reached its peak and was in the process of being deflated." —Reuters news agency, January 2006, report on speech by Billionaire investor George Soros [13].
  • "Lately, I have been asked if we are in a real estate bubble. My answer is, "Duh!" In my opinion, this is the biggest real estate bubble I have ever lived through. Next, I am asked, "Will the bubble burst?" Again, my answer is, "Duh!"" —Robert Kiyosaki, 2005, All Booms Bust, author of Rich Dad, Poor Dad.
  • "No one who makes a living in real estate really wants to see the end of this immensely profitable boom. For that matter, neither do most homeowners, who have been treating their homes like ATM machines and relying on price boosts to fund everything from retirement to vacations in Aruba. … But please don't shoot the messenger. My job is to report facts and expert opinions, even if the news is unwelcome. And every forecast I've heard from economists and other experts has projected a cooling of the U.S. housing market this year (though how quickly and by how much remain matters of debate), fueled by such factors as rising interest rates and lack of affordability. Even real-estate trade associations are predicting the boom's demise. … Across the country, real-estate agents tell me, the number of days houses sit on the market is creeping up, and inventory levels are on the rise. Both are early warning signs that prices are poised to fall. And according to the latest statistics from Foreclosure.com, which offers a database of U.S. foreclosure, preforeclosure, government-owned, and bankruptcy properties available to private individuals and tracks the number of these properties, new foreclosures were up 9% in February [2006] over the year before. If this trend holds, the company says, new foreclosures will reach higher levels this year than they have in previous years, especially in places like California and Nevada, where speculators are currently pulling out of overheated markets. … It will take some time—perhaps a few months—for homeowners to come to grips with the fact that their vinyl-clad nest eggs aren't expanding anymore, or, in some overheated markets, may even be shrinking. But once they do, they'll be more likely to guard them, and less likely to tap into them for everyday expenses. According to Freddie Mac, the nation's second-biggest buyer of mortgages, the amount of cash home buyers took out of their homes, which reached an estimated $243 billion last year, will fall by more than half in 2006, to about $117 billion. … Your success in good markets and bad teaches us a valuable lesson in how to weather the changes ahead: Do your homework, and don't get greedy." —The Wall Street Journal, Is There Still Profit to Be Made From Buying Fixer-Upper Homes?, by June Fletcher, author of House Poor: Pumped Up Prices, Rising Rates, and Mortgages on Steroids—How to Survive the Coming Housing Crisis) [italics added].
  • "The crux of the debate is house prices. If the inflated prices are justified by economic fundamentals and sustainable, then the 82 percent increase in mortgage debt since 2000 will probably turn out to be innocuous and the risks to the economy minimal. If, on the other hand, prices are out of whack, painful adjustments lie ahead. Unfortunately, the weight of the evidence strongly suggests a bubble. The price of the median home is up an inflation-adjusted 50 percent during the last five years, an unprecedented national increase. … Just as cheerleaders of the high-tech bubble of the late 1990s developed ever more creative explanations for why traditional metrics of valuing stocks no longer applied, the same has been true during the housing bubble. Housing bulls point to immigration, building restrictions, Baby Boomer demand for second homes, and other seemingly plausible justifications for skyrocketing home prices. But examining the value of housing using time-tested and common-sense metrics such as price-to-income and price-to-rent ratios suggest the gains in the bubble areas can't be explained by economic fundamentals. … People are buying in the face of sky-high prices because they've seen so many of their friends or relatives make a fortune in real estate; besides (they tell themselves), everyone knows real estate prices never fall. As with the stock market during the tech bubble, many are basing purchasing decisions not on underlying economic value, but on what they think they can sell a property for in the future—the very definition of a speculative bubble. … Even flat home prices would therefore slow economic growth unless other parts of the economy rapidly accelerate. But a hard landing—meaning a recession—is a real risk. If home prices fall modestly, millions of homeowners will see their equity wiped out. Many of those with the least amount of equity, as we've already shown, are going to face significant increases in their monthly payments. So what has been a virtuous but unsustainable cycle for the economy—higher home prices, more borrowing against home equity, higher spending, increased job creation, even higher home prices—could easily reverse and become a vicious cycle—higher monthly payments, declining home prices, less spending, job losses, foreclosures, even lower home prices." —The Weekly Standard, 10 April 2006, Housing Bubble Trouble: Have we been living beyond our means?, by Andrew Laperriere.
  • "Let's assume for a moment that enough people get fooled, and the refinancing boom gets extended for another year. Then what? The real problem hits. Because if you think Greenspan's being cagey on refinancing, the truth he's really avoiding talking about is that we're in the midst of a huge housing bubble, on a scale only seen once before since the Depression. Worse, the inflated housing market is now in an historically unique position, as the motor of the rest of the economy. Within the next year or two, that bubble is likely to burst, and when it does, it very well may take the American economy down with it." —Washington Monthly, April 2004
  • "There is a sharp debate over whether there is a bubble in the U.S. housing market generally or in certain localities, or whether there is a bubble at all. But the past two days have brought fresh warnings that home prices are unsustainable." —Forbes 2005 March
  • "There's a speculative element in home buying now," said David Lereah, chief economist of the National Association of Realtors. —Reuters May 24, 2005
  • "There's clearly speculative excess going on," said Joshua Shapiro, the chief United States economist at MFR Inc., an economic research group in New York. "A lot of people view real estate as a can't lose." —New York Times May 25, 2005
  • "People in much of the world are still overconfident that the stock market, and in many places the housing market, will do extremely well, and this overconfidence can lead to instability. Significant further rises in these markets could lead, eventually, to even more significant declines. The bad outcome could be that eventual declines would result in a substantial increase in the rate of personal bankruptcies, which could lead to a secondary string of bankruptcies of financial institutions as well. Another long-run consequence could be a decline in consumer and business confidence, and another, possibly worldwide, recession. This extreme outcome—like the situation in Japan since 1990 writ large—is not inevitable, but it is a much more serious risk than is widely acknowledged." —Yale University economist Robert J. Shiller, 2005, Irrational Exuberance (second edition)
  • "Alan Greenspan, the United States’ central banker, warned American homebuyers that they risk a crash if they continue to drive property prices higher. … On traditional tests, about a third of U.S. local homes markets are now markedly overpriced." —Times Online August 27, 2005
  • "The home-price bubble feels like the stock-market mania in the fall of 1999, just before the stock bubble burst in early 2000, with all the hype, herd investing and absolute confidence in the inevitability of continuing price appreciation. My blood ran slightly cold at a cocktail party the other night when a recent Yale Medical School graduate told me that she was buying a condo to live in Boston during her year-long internship, so that she could flip it for a profit next year. Tulipmania reigns." —Robert J. Shiller, quoted in Barron's article "The Bubble's New Home", June 20, 2005.
  • "Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors. These days, the only thing that comes close to real estate as a national obsession is poker." —Robert J. Shiller, 2005, quoted in Barron's article "The Bubble's New Home", June 20, 2005.
  • "[E]conomists have been wrong before when they try to call the market. Three years ago, Dean Baker, co-director of the Center for Economic and Policy Research in Washington, said that it would be only a matter of months before prices began to fall. Prognosticators at the research firm Economy.com declared that the peak was last summer. Celia Chen, the firm's director for housing economics, is now saying that it will come this year." [14]
  • "The generalized bubble in housing prices is comparable to the bubble in stock prices in the late 1990s. The eventual collapse of the housing bubble will have an even larger impact than the collapse of the stock bubble, since housing wealth is far more evenly distributed than stock wealth." —Dean Baker, July 2005, "The Housing Bubble Fact Sheet" PDF file, Center for Economic and Policy Research.
  • In a report called "The U.S. Housing Bubble—The case for a home-brewed hangover", HSBC Securities U.S. economist Ian Morris says home prices are out of whack when compared to rental prices, income and other key indicators.
  • "The overheating is greatest in markets such as Los Angeles, San Francisco, San Diego, Washington, New York, and Boston. The takeoff in coastal real estate started around 2000—suggesting that the speculative fever of the late 1990s did not die but instead jumped from stocks to real estate. From 2000 through the first quarter of 2004, single-family home prices are up at an annual rate of 8.2% in the Pacific region, 8% in New England, and 7% in the Middle Atlantic region, according to the Office of Federal Housing Enterprise Oversight. Prices rose 18% in Los Angeles, 14% in Miami, and 13% in Washington in the year through the first quarter, says the agency. … Today's housing prices are predicated on an impossible combination: the strong growth in income and asset values of a strong economy, plus the ultra-low rates of a weak economy. Either the economy's long-term prospects will get worse or rates will rise. In either scenario, housing will weaken." [16]
File:Economist-06-15-2005.jpg
The Economist magazine cover (16 June 2005) for the article "After the fall: Soaring house prices have given a huge boost to the world economy. What happens when they drop?".

Evidence of U.S. housing bubble

Searching the Arizona Regional Multiple Listing Service (ARMLS) shows that in early March 2006, the for-sale housing inventory in Phoenix has grown to about 35,000 homes, of which nearly half are vacant (see graphic) [17].

Boston Globe, January 11th, 2006. "Adjustable-rate loans come home to roost: Some squeezed as interest rises, home values sag" [18]

Business Week, December 19th, 2005. "Bubble, Bubble—Then Trouble: Is the chill in once-red-hot Loudoun County, Va., a portent of what's ahead?" [19]

Boston Globe, December 9th, 2005. "Sellers chop asking prices as housing market slows: Cuts of up to 20% are now common as analysts see signs of a 'hard landing'." [20]

"In the last eight years the country has experienced an unprecedented run-up in housing prices, as home prices nationwide have risen by 35 percent (adjusted for inflation)." [21]

Homeowners' equity is 55% of housing value, down from 72% in 1986, according to Federal Reserve data.

The ratio of house prices to median family income is 19% above the 1975-2000 average, according to data from the Office of Federal Housing Enterprise Oversight and the Census Bureau.

Inventory of houses for sale in Phoenix, AZ from July 2005 through March 2006. As of 10 March 2006, well over 14,000 (nearly half) of these for-sale homes are vacant [1]. (Source: Arizona Regional Multiple Listing Service.)
File:Ma sfh yoy.20060324.gif
Massachusetts Single Family Home Year-Over-Year Inflation Adjusted Prices, 2004–2006, from publically available U.S. government and Massachusetts Association of Realtors data. (Source: bostonbubble.com.)

See also

Further reading

Sources: Business and Opinion Newspapers and Magazines

Sources: Weblogs

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