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03-14-2007, 10:25 AM
“Bubble or Gas Pocket?” Myths Abound to Explain a Housing Bubble
Just about everyone seems to be discussing a housing bubble these days, which this has given, rise to much conjecture. Is the bubble for real? How serious is it? When will it pop? What will be the consequences? Here are some myths about a bubble, and the reality behind the myths.
Myth: The nation is in a housing bubble.
Much of the talk of a bubble is based on anecdotal reports in local markets like Boston or Los Angeles; e.g., houses are on the market for shorter times; sellers receive multiple offers; homes are sold for more than the listing price. These bits and pieces have been aggregated into a picture of a bubble enveloping the U.S. – what’s true in Boston must be true everywhere. But there is no national bubble, rather, there are “gas pockets,” or bubbles in certain markets.
Myth: People know a bubble when they see one.
Actually, people differ over what constitutes a bubble, whether a market is in a bubble, and the size of a bubble – big bubble or bubblette? So, what is a bubble? Essentially, it’s a rapid increase in a market’s housing prices that cannot be sustained by the underlying economic fundamentals. In bubble markets, prices are increasing 20% or more annually, and at a faster rate than justified by growth in jobs, personal income, household formations, consumer confidence or other economic measures. Other signs of a bubble are that housing prices far exceed rents for equivalent housing or the supply of land is far greater than required to meet demand.
This is an example of a bubble market:
Housing prices have increased 36% in the past year and 65% in the past three years. The average mortgage payment is 50% higher (or more) than the rent for equivalent housing. The market has an eleven-year supply of homes. Less than five percent of the market’s population has the income to qualify for a standard (conforming) mortgage. Two parcels in the market, Parcel A and Parcel B, are similar in size, shape, topography and zoning. Parcel A sold in 2004 for $91 million. Parcel B is on the market for $100 million. Welcome to bubbletown.
Possible bubble markets currently include condos in South Florida, on Florida’s West Coast and in Orlando, and single-family homes and condos in Las Vegas, Phoenix, and some urban areas in California. The Washington, D.C., metropolitan area might seem like it’s in a bubble, but price increases in that market have been supported by strong growth in high-paying jobs. By contrast, South Florida has had relatively weak job growth.
Myth: People who buy homes as investments are partly to blame for housing bubbles.
The problem is that all investors have been lumped together. Some investors are speculators, many others are true investors. Speculators are buying homes with little or no money down and planning to quickly resell or flip them at higher prices. Investors are buying homes for all cash or substantial down payments and planning to hold them as long-term investments that generate rental income. The number of investors is growing partly because more baby boomers are approaching retirement and looking for new investment opportunities.
Myth: The wide availability of interest-only loans has caused some markets to bubble over.
Interest-only loans are the most recent and fastest-growing mortgage product. More first-time buyers are using them out of necessity – it’s the only way they can afford a home in high-priced markets. These buyers have helped to increase demand for housing and push up prices in some markets. If mortgage interest rates were to increase, some of these buyers might be caught in a financial squeeze and have to sell their homes. This could have the effect of increasing the number of for-sale properties on the market and slow price appreciation.
What is not as widely known is that many other buyers are choosing interest-only loans. For example, about two-thirds of the customers of a mortgage banking unit of an investment banking firm use such loans so they don’t have to tie up a lot of capital in housing but can use it for stock and bond investments or other financial purposes. These borrowers generally could absorb higher interest rates and would not be under pressure to sell their properties.
Myth: Home builders like bubbles because they can sell more homes at higher prices.
Builders see bubbles as a risk, not an opportunity. In bubble markets, speculators try to buy homes in a tract or subdivision and quickly sell them at higher prices, often in competition with the builder’s homes. If there is a housing downturn for some reason, speculators could dump their houses at depressed prices. That would bring down prices of other homes in the same market, and the builder would get the blame for selling to speculators in the first place.
Builders are using a number of tactics to ward off speculators. Sales people are trained to discreetly screen for prospective buyers who do not intend to live in their homes but are buying them as investments. (Builders are not required to sell to these investors.) Some mortgage application software is designed to identify prospective investors, e.g., by asking how many homes a buyer already owns. Builders are including a requirement in sales contracts requiring buyers to live in their homes for at least a year. They are limiting the number of homes a buyer may purchase, and they are not allowing buyers to assign purchase contracts to other buyers.
Myth: The housing bubble could pop if mortgage interest rates increase or the economy slows.
In many bubble markets, the bubble may not pop; instead, it may slowly leak air, meaning sales might slow and prices increase more slowly, closer to historical rates, but there would not be a precipitous drop in prices. To many builders and mortgage lenders, a housing slowdown might be a good thing, removing the speculative froth from housing markets and bringing more stability.
Just about everyone seems to be discussing a housing bubble these days, which this has given, rise to much conjecture. Is the bubble for real? How serious is it? When will it pop? What will be the consequences? Here are some myths about a bubble, and the reality behind the myths.
Myth: The nation is in a housing bubble.
Much of the talk of a bubble is based on anecdotal reports in local markets like Boston or Los Angeles; e.g., houses are on the market for shorter times; sellers receive multiple offers; homes are sold for more than the listing price. These bits and pieces have been aggregated into a picture of a bubble enveloping the U.S. – what’s true in Boston must be true everywhere. But there is no national bubble, rather, there are “gas pockets,” or bubbles in certain markets.
Myth: People know a bubble when they see one.
Actually, people differ over what constitutes a bubble, whether a market is in a bubble, and the size of a bubble – big bubble or bubblette? So, what is a bubble? Essentially, it’s a rapid increase in a market’s housing prices that cannot be sustained by the underlying economic fundamentals. In bubble markets, prices are increasing 20% or more annually, and at a faster rate than justified by growth in jobs, personal income, household formations, consumer confidence or other economic measures. Other signs of a bubble are that housing prices far exceed rents for equivalent housing or the supply of land is far greater than required to meet demand.
This is an example of a bubble market:
Housing prices have increased 36% in the past year and 65% in the past three years. The average mortgage payment is 50% higher (or more) than the rent for equivalent housing. The market has an eleven-year supply of homes. Less than five percent of the market’s population has the income to qualify for a standard (conforming) mortgage. Two parcels in the market, Parcel A and Parcel B, are similar in size, shape, topography and zoning. Parcel A sold in 2004 for $91 million. Parcel B is on the market for $100 million. Welcome to bubbletown.
Possible bubble markets currently include condos in South Florida, on Florida’s West Coast and in Orlando, and single-family homes and condos in Las Vegas, Phoenix, and some urban areas in California. The Washington, D.C., metropolitan area might seem like it’s in a bubble, but price increases in that market have been supported by strong growth in high-paying jobs. By contrast, South Florida has had relatively weak job growth.
Myth: People who buy homes as investments are partly to blame for housing bubbles.
The problem is that all investors have been lumped together. Some investors are speculators, many others are true investors. Speculators are buying homes with little or no money down and planning to quickly resell or flip them at higher prices. Investors are buying homes for all cash or substantial down payments and planning to hold them as long-term investments that generate rental income. The number of investors is growing partly because more baby boomers are approaching retirement and looking for new investment opportunities.
Myth: The wide availability of interest-only loans has caused some markets to bubble over.
Interest-only loans are the most recent and fastest-growing mortgage product. More first-time buyers are using them out of necessity – it’s the only way they can afford a home in high-priced markets. These buyers have helped to increase demand for housing and push up prices in some markets. If mortgage interest rates were to increase, some of these buyers might be caught in a financial squeeze and have to sell their homes. This could have the effect of increasing the number of for-sale properties on the market and slow price appreciation.
What is not as widely known is that many other buyers are choosing interest-only loans. For example, about two-thirds of the customers of a mortgage banking unit of an investment banking firm use such loans so they don’t have to tie up a lot of capital in housing but can use it for stock and bond investments or other financial purposes. These borrowers generally could absorb higher interest rates and would not be under pressure to sell their properties.
Myth: Home builders like bubbles because they can sell more homes at higher prices.
Builders see bubbles as a risk, not an opportunity. In bubble markets, speculators try to buy homes in a tract or subdivision and quickly sell them at higher prices, often in competition with the builder’s homes. If there is a housing downturn for some reason, speculators could dump their houses at depressed prices. That would bring down prices of other homes in the same market, and the builder would get the blame for selling to speculators in the first place.
Builders are using a number of tactics to ward off speculators. Sales people are trained to discreetly screen for prospective buyers who do not intend to live in their homes but are buying them as investments. (Builders are not required to sell to these investors.) Some mortgage application software is designed to identify prospective investors, e.g., by asking how many homes a buyer already owns. Builders are including a requirement in sales contracts requiring buyers to live in their homes for at least a year. They are limiting the number of homes a buyer may purchase, and they are not allowing buyers to assign purchase contracts to other buyers.
Myth: The housing bubble could pop if mortgage interest rates increase or the economy slows.
In many bubble markets, the bubble may not pop; instead, it may slowly leak air, meaning sales might slow and prices increase more slowly, closer to historical rates, but there would not be a precipitous drop in prices. To many builders and mortgage lenders, a housing slowdown might be a good thing, removing the speculative froth from housing markets and bringing more stability.