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April 01, 2005
Is it near the end of the housing bubble?

OK, there's a housing bubble. There are now many books telling you how to get rich buying real estate. They include titles such as Real Estate Miracles, The Baby Boomer Vacation Real Estate Boom, and How to Buy Real Estate and Walk Away with Cash.
It seems that people have grown disinterested in stock speculation and are trying their hand at being real estate moguls.
As a rule of thumb, a real estate investment is considered a good buy if you can purchase it at 100 times what you can get for a monthly rental payment.

What is fueling the Housing Bubble? This answer is the simplest: Mortgage rates are at a 40-year low. In 1982 mortgage rates were at a lofty 16 percent and have been dropping steadily to about 5 percent! When mortgage rates drop, monthly mortgage payments decrease as well. This decrease makes housing more affordable, which in turn triggers a bull market in housing prices.

A major sign that we are in a housing bubble is the fact that fewer people can afford homes. Housing prices have been rising at a vastly higher rate than incomes. Now more people are unable to afford the average home in their town. A housing bubble needs a steady stream of thirsty home buyers. If housing is significantly less affordable, then who is left to keep buying to prop up home values? No one! Overheated real estate prices are going to collapse plain and simple. This is just a real life example of supply and demand.

What concerns experts most about the bubble is one of its least-recognized characteristics: the use of leverage. The sharp jump in leverage in recent years has had a dramatic influence on the earnings of the homebuilding companies. Many investors think that homebuilders' earnings-growth trends will remain strong. Implicit in that assumption are two others: mortgage debt outstanding will increase significantly, and the consumer sector's balance sheet will decline significantly from current levels.

If you see is time to see the tail end of a bubble, some people cannot believe it can go down much because the baby boomers are going to retire and will not stop buying properties.
But what has really fueled the real estate craze is the low rate of interest Alan Greenspan has given us. Even the Federal Reserve is starting to believe that real estate is getting out of hand.
In a testimony to Congress about the economy, Alan Greenspan pointed out that rising real estate values have kept consumer spending going and have contributed to our low national savings rate. He said:
"The sizable gains in consumer spending of recent years have been accompanied by a drop in the personal saving rate to an average of only 1 percent over 2004, a very low figure relative to the nearly 7 percent rate averaged over the previous three decades. Among the factors contributing to the strength of spending and the decline in saving have been developments in housing markets and home finance that have spurred rising household wealth and allowed greater access to that wealth."
"Of course, household net worth may not continue to rise relative to income, and some reversal in that ratio is not out of the question. If that were to occur, households would probably perceive the need to save more out of current income; the personal saving rate would accordingly rise, and consumer spending would slow. "

The Federal Reserve saw what effects the fallout of a stock market bubble had on the economy and is most likely worried that the implosion of a real estate bubble would have similar - if not worse - consequences.

Mortgage rates will not stay low forever as this low rate environment cannot be preserved for much longer. When rates do rise, housing prices will fall as prospective home buyers will be discouraged by higher monthly mortgage payments. After the housing bubble pops, prices will likely plummet for at least a decade, unfortunately. Too pessimistic? Consider this: After the 1989 Japanese housing bubble, housing prices tanked for 13 straight years! The Japanese housing bubble was a similar situation to what we are currently experiencing.

Even if the housing crash is not nearly as drastic, it could still take at least 9 years to recover. This is precisely what occurred after 1988 as the United States housing boom ended. National housing prices finally reached previous 1988 levels in 1997!

The quarterly House Price Index (HPI) report issued by the Office of Federal Housing Enterprise Oversight (OFHEO) in March shows there may be a slow leak in the housing bubble. The house price appreciation for the entire year of 2004 was 11.17 percent, and for 2005 the most recent figure represents an annual rate of only 6.77 percent.
OFHEO Director Armando Falcon, Jr. Said: "This report reflected a slowing of the tremendous house price appreciation we've seen recently, but it (housing prices) is still growing at a strong pace."

So, maybe the end of the bubble will come in 2006.

Gregorio Melean

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