www.foxnews.com/story/0,2933,167141,00.html
LINKS Dear Friends, Just as it was impossible to pick up a newspaper or magazine in late 1999 that didn't have a story about over-priced tech stocks, so it is today when it comes to residential real estate.
As Yale economist Robert Sh iller sees it, talk positive on the upside and negative on the downsid e both creates and destroys financial bubbles. That's not to say there is universal agreement that real estate prices ar e, in fact, headed for the kind of collapse the stock market experienced , where $7 trillion in value was erased. Whats not in dispute is that the housing prices have been on a tear for at least the past five years, posting record gains in the past two. To b e sure, not all areas of the country have seen the 31 percent appreciati on experienced in Nevada or the 19 percent jump in home prices Arizona h omeowners saw over a 12-month period. According to the Office of Federal Housing Enterprise Oversight, Texas, Colorado, Ohio, Oklahoma, and Indi ana were among the states that had the smallest increases. Nine straight hikes in short term interest rates have done little to damp en demand partly because, for reasons that even Federal Reserve Chief Al an Greenspan claims to not understand, long-term interest rates have not followed suit. April and July of this year c ame in second and third, respectively. And the Commerce Department just reported that sales of new homes set a new record last month. Although the economists and experts are scratching their heads over thi s, I can explain it! All you have to do is use common sense: If you were thinking about buying a home and saw interest rates going up, what woul d you do, wait? The prospect of higher mortgage rates prods ever yone whos been sitting on the fence to finally sign on the dotted line and close the deal! It runs counter to what you might think, but remember this: When interest rates start to rise, home sales go up, not down. At some point, of course, interest rates will get sufficiently high that they drive up monthly mortgage payments beyond the reach of most buyers. Because by just about any measure, theyre way out of whack in a lot of markets. Edward Leamer, an economist who heads the prestigious Anderson Forecast a t the University of California at Los Angeles, says one way to see this is to look at the real estate Price/Earnings ratio. As with stocks, it t ells you how much you have to spend to generate a dollar in earnings. In the case of housing, Leamer compares the average price of a home versus the annual cost of renting a 1500-square-foot apartment in 46 metropoli tan areas around the country.
Click on this link to see those that have had the smallest. Leamer cautions that looking at P/Es across different cities isnt that r elevant because, in his words, its not an apples-to-apples comparison. Whats more important is the P/E trend exhibited by a single city. For instance, take San Francisco, one of the hot housing markets. From 1989 to 2001 the price-to-rent ratio ranged from around 10 to 14. Last year it hit 23, nearly double its long-term average. That indicates rents have been flat to lower while h ome prices have climbed higher. With a stock, a high P/E is appropriate for firms expecting a lot of grow th. Likewise, according to Leamer, i f a region expected great economic growth in the future, demand for hous ing would go up as more people moved into the area. However, most people will interpret eco nomic growth as good, says Leamer, and will be willing to pay more for a home. As real estate prices increase, the P/E ratio returns to a more normal level. In Leam ers view, because interest rates have been so low, anyone who crawled off the street could get a mortgage. The obvious question is what happens when the prop of extremely low inter est rates no longer exists? According to figures compiled by the National Association of Realtors (NA R), the trade group for the industry, home prices have grown increasingl y unaffordable since 1998. Back then, a household earning the US avera ge family income had 41 percent more income than necessary to qualify fo r a mortgage on the average-priced home. Because of geographic differences in housing appreciation it doesnt begin to paint an accurat e picture of the real situation. The chart below breaks down housing aff ordability on a regional basis, based on household income and home price s As you can see, the cost of buying a home is now out of reach for the ave rage family that lives in the western part of the country. In just the p ast two years, prices have risen so far so fast that the typical famil y only has 80 percent of the income necessary to qualify for a mortgage on the typical home. Affordability is declining, even with very low interest rates, says Law rence Yun, senior economist for the National Association of Realtors. P rices have risen so much its becoming difficult to buy a home. He says home prices will continue to grow less and less affordable as mortgage rates increase. Still, Yun says there are fundamental reasons why weve seen the recent boom in home prices, including those markets that have experienced doub le-digit increases. Going forward we dont anticipate similar dramatic increases in prices, but we do anticipate further increases. He expects residential real estate appreciation will revert back to its historica l rate of 4-6 percent per year. But you have to wonder: if home prices have been going up faster than inc omes for years, whos going to be able to buy these properties in the fu ture? At some point, either prices have to come down, or sellers will ha ve to wait until the incomes of potential buyers catch up with their ask ing prices. And contrary to what a lot of so-called experts are predicting, Leamer, believes the pain will be felt on a national level, not just locally. A s an economist hes much more concerned about the broader implications o f a slowdown in the housing market than about the price bubbles some are as are experiencing. Weve had ten economic downturns since World War II and eight of them st arted in the housing sector. Its the first component of gross domestic product that starts to weaken, says Leamer. He keeps a close eye on wha t consumers spend on housing because it has a ripple effect, pointing ou t that a decline will lead to layoffs in construction, banking, and the real estate industry, to name just a few areas. In Leamers view, the housing market appears to have peaked in Californi a and elsewhere. It will take more than a year for this weakness to turn into job losses and to affect the economy in general. Leamer lays the blame squarely on the Federal Reserve for leaving interes t rates too low for too long. Now, he says, were not only heading for t rouble in the housing sector, but in the auto industry another market that got drunk on historically low rates. Low borrowing costs accelerated future sales by enticing consumers to tra de up to bigger homes and new vehicles sooner than they might have done otherwise. Instead of waiting to buy a new family car in a couple of yea rs, folks said, Oh, what the heck. As a result, car dealers lose the sale they would have gotten two years from now. As rates creep higher, consumers happily driving their new cars or living in their larger homes have no motivation to purchase additional ones. S ince consumer spending drives two-thirds of our economy, when consumers close their wallets, the impact is far-reaching. While the real estate bubble itself may be all about location, location, location, in Leamers view the coming housing slowdown will have natio nal implications, although areas that have benefited most from the housi ng boom are likely to be hit hardest. He says the strong housing market created a lot of jobs in construction, in banking, in real estate. If that disappears, a basic driver for the local economy disappears. In his view areas with a more diversified income base, such as manufacturing communities, are likely to weather the coming economic decline better. If youve been shopping for a home, Leamer says you need to recognize th e risk and do some hard-nosed thinking about whether you should t...
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