Real Estate Bubble Debate

Globe warns "Mortgage trend poses risks in downturn"

My compliments to the Boston Globe for running their third front page story on real estate in the last four weeks (see previous blog posts on May 20th and May 3rd).  Today's lead story, Mortgage trend poses risks in downturn, is the first to raise cautions about the downside of the real estate bubble to the lead headline and includes an alarming graph showing that interest-only loans and adjustable rate loans made up about 70 percent of all loans in Massachusetts last year, and just under 60 percent currently.  Those market trends are even more troublesome when one adds no money down deals or sub-prime loans. According to the Washington Spectator, one in four loans nationwide involve sub-prime loans. 

So what is any ordinary buyer to do now to protect themselves, now that there are signs the real estate market has peaked as reported six days ago in another Globe story entitled:  State home sales sag 10% in April?

The Wall Street Journal's online site, RealEstateJournal.com, has been raising concerns about risky loans since last fall, and has written a number of articles to help buyers "Know the Real Price of New Mortgages."  One encourages buyers to exercise due diligence and includes a link to an innovative negative-amortization calculator:

If you're considering an ARM and aren't sure whether a sudden jump in rates would break the bank, ask your broker to run a worst-case scenario for monthly payments and outstanding loan balance, based on the highest rate you could potentially be charged. This negative-amortization calculator from the Web site of Jack Guttentag, professor emeritus at the Wharton School of the University of Pennsylvania, also offers a stark look at how homeowners with these types of loans can get burned should interest rates turn sharply higher.

If as the Globe writes, "analysts fret over use of interest-only loans," you should look carefully, too, particularly if you are first-time homebuyer.  Real estate decisions involve a complex, imprecise set of factors and online calculators "don't take into account individual circumstances" as the WSJ wrote in an article a year ago on "Five Reasons to Remain in Your Rental Property."  Today's lead story on "timing the market" in RealEstateJournal.com says some long time homeowners are "tempted to sell, reap a huge profit -- and rent for a while to wait until prices possibly come down." 

Locally, that could result in more inventory on the housing market, and softening prices -- regardless of what kind of loan you use -- by the end of the year.  If "worse-case scenarios" play out and new homeowners are forced to sell in coming years because of they can no longer afford monthly payments on their interest-only or adjustable rate mortgages, today's rising inventory of unsold homes could become bloated and some sellers may be forced to sell at a loss.

 

That man is richest whose pleasures are cheapest

A New York Times article entitled "Billionaires Beware This Bubble" reports that Worth Magazine's cover story this month "makes a convincing case that there may be a bubble on the extremely high end of the market."  While overly optimistic resort developers believe that the rising number of wealthy households will offset downward pressure felt in other price ranges, MIT Economist William Wheaton argues that resort buyers will substitute "the next mountain or beach or lake" in search of lower prices, and Christopher Mayer of the Columbia Business School says that supply will "outstrip demand, depressing prices."

Falling high-end prices are not limited to resort communities.  In a March 2005 article on their Luxury Housing Affordability Index, Business Week reported that "Luxury housing became significantly more affordable in Boston and Chicago, where prices fell a little over 10%; in Miami, down 6%; and Washington, D.C., down about 7%."

A year earlier on Valentine's Day 2004, The Real Estate Cafe released it's own study entitled "Sweetest Deals of 2003:  The Year of the Million Dollar Markdown."  At that time, only 50 properties in the MLS had ever been marked down by $1 million dollars in Greater Boston and 30 of them occurred in 2003.  That price correction helped trigger a comeback and record setting pace for luxury homes in the first quarter of 2004.

What's happening now in the multi-million dollar price range in Greater Boston?  Our sense is that the supply of multi-million dollar homes continues to rise as the demand remains relatively flat (see graph above through 2003) causing downward pressure on prices.  How far down?  Ask us after Halloween, that's when most of the million dollar markdowns took place two years ago. 

The NYTimes article puts the prospect of losing real estate wealth in perspective with some statistics and a parable about personal happiness.  First, "6.6 million Americans 65 and older - 22 percent of all older beneficiaries - have no income other than Social Security.  The average monthly benefit for retirees is about $955."  Then, in a touching tale of "diminished - yet satisfying - expectations," a former world traveler, now retired, told the Times, "For 75 cents I can ride down to the airport, walk around the international terminal, and watch all the people headed for their planes. For me, that's enough of a travel fix." 

While that simple soul is not a billionaire or a casualty of the real estate bubble, his contentment reflects the wisdom of one of Boston's favorite sons, Henry David Thoreau, who once said, "That man is richest whose pleasures are cheapest."  That's a comforting perspective our real estate obsessed culture may have forgotten. 

Single family sales drop 10% in MA

Real estate headlines seem to be everywhere these days, from today's lead story in USA Today, -- the second in two weeks, to Monday's "Condo a Go-Go" story and slide show in the New York Times, to Saturday's story in the Washington Post about a Playboy centerfold who is giving up her modeling to become a real estate investor. 

Despite those sexy news angles and industry spin that "everything is coming up roses," the most revealing finding for home buyers and sellers in Massachusetts is today's Boston Globe Business headline: 

State home sales sag 10% in April. 

According to the Massachusetts Association of Realtors, the number of single-family homes sold in April was down 10.4 percent from 2004, marking the first double-digit decline since April 2003.

After years of warnings, is Boston in for a Real Estate Reality Check?  That was the title of today's talk show on The Connection, a nationally syndicated radio program, which will be rebroadcast in Boston at 9pm this evening on 90.9FM and archived online.

Wellesley economics professor Karl Case, cofounder of CSWv.com and partner of Robert Shiller, told the Globe, ''I think we are beginning to see the beginning of a soft period."  His comments could foreshadow the slide in housing prices, forecast last week by the New England Economic Partnership, that could last through 2007.

If you are a buyer or seller in Massachusetts has your thinking begun to change about whether this is a good time to buy or sell, and what are you doing to protect yourself?  Want to talk about it online, or at a monthly "Bubble Hour" where you can share insights and questions with other consumers?

Three Percent Drop or The China Scenario?

Two weeks after we challenged frothy assertions about the housing market in a page one story in the Boston Globe, the real estate bubble is back on the front page.  This time instead of quoting brokers and builders, the Globe turned to a more credible source:  the New England Economic Partnership.  They forecast "a modest housing slump in Massachusetts that will last through early 2007, with prices, at the bottom, declining about 3 percent." 

While NEEP projects that falling prices will be offset by a strengthening regional economy, Princeton Economist Paul Krugman paints a much bleaker scenario in his editorial, The Chinese Connection, in today's New York Times. Here's a snippet:

"Here's what I think will happen if and when China changes its currency policy, and those cheap loans [to the US treasury] are no longer available. U.S. interest rates will rise; the housing bubble will probably burst; construction employment and consumer spending will both fall; falling home prices may lead to a wave of bankruptcies. And we'll suddenly wonder why anyone thought financing the budget deficit was easy."

Earlier this week, Krugman told an audience in Bangkok, "There is a real bubble mentality in the US housing market,'' adding that prices of US housing were 250% of their real values.

So if one's perception of the regional, national, and global economies determines one's belief about whether the housing bubble will deflate or burst, where do you stand?  We'd love to hear your perspective, particularly if you are buying or selling this Spring.  (If you do decide to buy despite the real estate bubble debate, we invite you to use our commission rebates as a cushion against a loss in value.  If you're selling, why not try for sale by owner to maximize your equity particularly if prices begin to slide in the second half of 2005?)

Co-authored by Bill Wendel and Douglas McCarroll, our newest real estate consultant / buyer agent at The Real Estate Cafe

Realtors' economist on "indicators of a market headed for a bust"

The Wall Street Journal hosts a forum on the real estate bubble which is worth visiting.  An excerpt from a recent post, which includes comments from a presentation last Thursday by the National Association of Realtors' chief economist, is shown below.  His presentation, which I've heard in person over the past four years, was considerably different in tone and substance as the quote below attests.  We'll continue to use this blog to track the factors he suggests are "indicators of a market headed for a bust" and invite your comments.  It will be interesting to hear what local economist Karl Case, partner of Robert Shiller famed author of Irrational Exuberance, says tomorrow morning on WBUR's Morning Edition.  If you are in Boston, be sure to tune into NPR at 90.9fm.  We'll link the story as soon as the audio clip is available online.

Bubble News -

This is a great news from the head of the real-estate bubble, David Lereah... seems his tune has changed bit. Local Housing Bubbles Could Burst in Next Couple of Years.

"Lereah, during a presentation Thursday at the National Association of Realtors' midyear meetings, said he expects that some hyper-extended local real estate markets will sour within the next couple of years.

'Loose lending and speculative buying – that, in my opinion, is the greatest risk that our industry faces right now,' Lereah said.

Most local 'balloons' in home prices 'will deflate rather than pop,' though 'several local markets will pop over the next couple of years,' he said.

Among the indicators of a market headed for a bust: home sales falling, price growth below historical average, more than a 6.5-month supply of housing, properties taking longer to sell, job loss in the area, rising mortgage rates, negative net migration, and rising loan-to-value ratios.

Wanna-be Homeowners in Harm's Way?

Thinking about using an interest-only loan or adjustable rate mortgage (ARM) to stretch your purchasing power this Spring?  Read this article cautionary article in the WashingtonPost.com to make sure you don't become one of those Homeowners in Harm's Way when rates go back up and prices soften or fall.  Whether you're househunting on your own or working with another buyer agent, have you given any thought to whether we're in a real estate bubble and how you can protect yourself from the scenario described in the article:

"...if rates return to the levels that might have been considered reasonable just a few years ago -- say, 7 or 8 percent -- ARM holders would face big payment jumps.

...In addition, rising rates will put downward pressure on home prices because fewer buyers will be able to qualify for loans with bigger payments. Further, if some ARM borrowers become unable to meet their higher payments and therefore put their houses on the market, that will add to the downward pressure.

The result could be a serious slump in the housing market, and a lot of pain for some families."

None of us has a crystal ball, so your opinion is as good as ours.  Feel free to post your comments below, and please let us know if you'd like to attend a monthly "Bubble Hour" to exchange perspectives with other potential home buyers and sellers.

Will gas prices drive down the cost of housing?

Ever wonder what real estate professionals say about the real estate bubble when their clients aren't around?  After reminding agents that "Great real estate booms in our country can be followed by great declines in property values," an industry expert writing today in RealtyTimes used the starkest language to describe a new factor in the growing list of downward pressures on housing prices:

"Investment experts on Wall Street are predicting that gasoline prices here in the USA will reach $4 to $5 a gallon within the next several years. And one of the oil industry's most respected investment bankers says that he sees the price of gas ballooning to $7 a gallon in the years ahead. There's simply so much more demand for petroleum from expanding economies in Asia..."

Have rising gas prices (as shown on this pump in Waltham near Route 128) already influenced where you are house hunting, or shifted your thinking about the real estate bubble?  Do you think prices could really rise above $5 per gallon?  At what price would commuting costs change where you would chose to live? 

Failing grade for front page froth on condo conversions

Real estate is back on the front page of the Boston Globe today with a photo and headline which reads "Condo Conversions Spreading."  Despite 22 paragraphs and three graphs, the story fails to cross examine frothy quotes from local developers and brokers perpetuating the myth that "real estate is 'a great investment'" for ordinary home buyers in today's market.

Acknowledging that, "many are betting that real estate will provide better investment returns than the stalled stock market," the Globe fails to look critically at the fundamentals behind that assumption.   

For starters, the story focused on emerging housing markets, but failed to point out that fringe areas are the last to rise in a housing bubble and first to fall in a housing slump. 

Second, the story quotes one local broker who asserts  that "15 percent of the city's condos are purchased purely as investments," but fails to note that the National Association of Realtors reports that investors made 23 percent of purchases nationwide.

Third, the Globe quotes an overly enthusiastic Dorchester-based real estate agent who claims that, "The second a building comes on the market in the hot areas, ...It sells immediately" but fails to balance that rosy assessment with statistics, reported two weeks ago by the Boston Herald, showing that foreclosures are up and prices are down in Dorchester and Roxbury.

Still "real estate is 'a great investment'" we are told by a developer. 

To their credit, the Globe reports that Yale professor Robert Shiller, author of ''Irrational Exuberance," foresaw the tech bubble in 2000 and "he predicts real estate may be next."  Instead of substantiating his position with a critical look at the underlying fundamentals, the story closes by quoting a real estate attorney who says strong demand will moderate any price correction in Boston. 

Is that kind of reporting causing false security in an overheated housing market where the price-to-income ratio in Boston is now 6.5 to 1?  Maybe investors can afford to make a mistake, but first-time home buyer commuting to remote markets to find affordable housing cannot, especially with rising gas prices.  They should know that a recent industry study ranked Boston as the housing market most likely to fall.  They should also be told that prices and demand are being driven by risky mortgages:  (1) one third of properties sold last year involved interest-only loans, (2) another third involved adjustable rate mortgage, and (3) still another quarter involved subprime loans.  Add amateur or "momentum investors" and there appear to be four shaky legs holding up an overheated housing market driven, in part, by high-profile real estate stories that report on the symptoms of the housing bubble without questioning the underlying fundamentals.