Real Estate Bubble: A Self-Fulfilling Prophecy?

There are plenty of naysayers about the real estate market and its unprecedented growth. Las Vegas-based ReviewJournal.com, for instance, has given cyber-print on a report by Doug Fabian, president of Fabian Wealth Strategies and Josh Lewis, first vice president at Santa Ana, Calif.-based Stearns Lending. The report, "Boom to Bust," says the following issues about current homeownership points to a possible bubble:

• Non-owner occupants are now buying more than 25 percent of all homes.
• Households are allocating a greater percentage of income to housing than ever before.
• More houses are being purchased with no down payment. People are buying primarily because of the expectation of appreciation.
• The majority of today's loans involve some combination of adjustable-rate mortgages, interest only or negative amortization.

The report states, "This layered risk will result in a major increase in foreclosures, which will bring the total housing market down in value." Unfortunately, this report brings up nothing new: people have been buying real estate for decades in anticipation of appreciation; also, during those years, households have been allocating a greater percentage of income to housing; and zero percent down payment mortgages have been around for just as long -- all of these factors have been true for the last 20 years.

Now take this report and compare it to the 2nd Quarter 2005 report issued by the U.S. Department of Housing and Urban Development on U.S. Housing Market Conditions and you see a different picture:

• The housing sector continued to be a major contributor to the U.S. economy during the second quarter of 2005.
• New records were set for single-family permits, new home sales, and existing home sales.
• Interest rates remained at less than 6 percent, but the challenge to affordability for new homebuyers grew.
• Compared to the most recent quarter, the median sales price of an existing home rose by 10.3 percent, and was 13.7 percent higher than a year earlier.
• Compared to the second quarter of 2004, permits for new homes were up 2.1 percent.
• Construction starts were up 4.6 percent.
• New housing completions increased by 4.7 percent.
• Sales of existing homes and new single-family units rose, by 4.6 percent and 10.2 percent, respectively.
• Permits and new starts for multi-family units slowed after the first quarter of 2005, but remained stronger than in the second quarter of 2004.

So why all this good news on the housing front -- basically, the economy is growing. And that, my friends, is why you have to second guess the concept of a bubble in the real estate market.
We've become accustom to the use of "bubble" because of the drop in the stock market of 2001, following unprecedented growth in several exchanges. The difference is that the stocks that inflated the bubble on the stock market were based on the founding of companies on investment money in hopes of finding the next internet-based fortune not on the actual production and profit-making of consumer products.

The inflation we are seeing in the housing market is because of economic growth, more jobs, population growth and the local jurisdictions not providing enough housing for this growth. It's pretty simple -- if you grow the economy, you must grow the housing base. However, in the last five years, metropolitan regions have taken the slow growth or limited growth approach to providing housing instead of pushing for more affordable housing in high density projects.

When the economy slows in any given jurisdiction is when you'll see trouble in your real estate market. For instance, in the Washington, D.C. area, home to the hottest employment growth in the country, the region is projected to create more than 82,000 jobs in 2005, according to the Center for Regional Analysis at George Mason University. However, the Center points out local builders are only allowed to put up about 35,000 houses per year.

If you're bringing in 50,000-plus new jobs into an area every year, but only build 30,000 houses -- is that a bubble or a true reflection of the supply and demand of housing? You be the judge.

Mr. Carr has covered real estate since 1989. He is the author of "Real Estate Investing Made Simple." Got a personal real estate issue? Questions can be posted at The Millennium Team's blog.

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