Bubble may burst in housing market; the strength of the U.S. housing market has defied recession, plunging stocks and business scandals, but signs indicate that the hot market soon may cool

Insight on the News, Dec 10, 2002 by Jamie Dettmer

Federal Reserve Chairman Alan Greenspan has sounded sanguine enough in recent weeks about the long run-up in house prides, but fears are mounting that the U.S. property market may be in a price bubble that could burst if the labor market doesn't start reviving soon. Certainly few economists believe the bubble won't pop once interest rates start rising again.

The regular assurances by the Fed chief about there being no irrational exuberance in the real-estate market ring hollow with many of his critics. They contend that only a few weeks ago Greenspan was arguing that he and the Fed were not to blame for the inflated stock prices of the 1990s, since price bubbles can't be identified until they burst [see the business, Oct. 1-14]. So, following that logic, how does he know the real-estate market isn't trapped in a price bubble?

For the last half-decade a rare combination of factors--including record-low mortgage rates, little unemployment, the easing of traditional credit standards and a tight housing supply--has prompted a surge in U.S. property prices, sending them skyrocketing. Even the recession, stock wipeouts, business scandals, the war on terror and a possible invasion of Iraq have failed to calm a frenzied property market that has seen prices jump 58 percent in Miami since 1998, 89 percent in Boston and 81 percent in the New York City suburbs of Long Island.

New home sales hit a record in July, and in the last half-decade the average selling price of existing homes in the United States as a whole has increased by 39 percent--8 percent in the last year.

With the stock market still in a bearish mood and fixed-return investments hardly worth the effort, many Americans have turned to the property market as a way of recouping their stock and 401(k) losses and preserving the value of their overall assets. The refinancing of mortgages has added to the exuberance of the property market. But as a result of the runaway appreciation, first-time buyers in many parts of the country are being priced out of the market. That in itself has led some property analysts to argue that price appreciation will slow or reverse until the market becomes more affordable again.

In more than 100 U.S. cities, home prices have climbed more than twice as fast as household incomes since 1998, including in large cities such as Atlanta, Las Vegas, Denver and Houston. This has shocked even veteran real-estate brokers. "The Boston area is still holding, and I don't know why," said Helen Babcock, manager of Carlson GMAC Real Estate. Meanwhile, sales are heading for yet another record year, but with layoffs increasing the market has to slow soon, say some skeptical economists and property analysts. "I have never seen an asset market--whether it's stocks or real estate--that has boomed to excessive prices without a serious downturn," Allen Sinai, chief global economist of forecasting firm Decision Economics, said recently.

Even so, some of the factors behind the housing boom show signs of fading. In New York City, Stefan Capan, an agent with Thompson Kane, thinks the crunch is coming as a result of the latest layoffs announced by Wall Street firms. "The prices here are still red-hot and the market is being driven by the rock-bottom mortgage rates," Capan tells INSIGHT. "But I think we will see a slowing down and then a reverse starting. Manhattan is starting to get the fall-out from the recession and 9/11."

With finance firms cutting staff and putting freezes on hiring, the waves of youngsters and the newly graduated are just not coming into Manhattan, Capan notes. He says the rental market has all but collapsed in Manhattan --something that traditionally suggests a weakening in the property market overall.

And signs elsewhere indicate that there's an approaching slowdown in the property market. In Atlanta, there is a 21-month supply of homes priced at $500,000 and above. And in the South and Midwest delinquencies on mortgages have hit record highs. In the nation's capital, which has had one of the hottest markets in the country in the last few years, homes that previously would have sold in a day still are without buyers after a month or so.

But Tom Williams, a well-known agent in the capital's metro area for Long & Foster, says the last few years have been like a "Californian gold rush." According to Williams, "We were in a badly distorted market in terms of too many buyers and too few properties for sale. That is changing, and houses that were going in a few days are now lingering on the market. Well-priced properties or very desirable ones are still going quickly and can get half-a-dozen offers quickly."

The Long & Foster agent doesn't believe there will be a real-estate bust in Washington and suspects prices will go flat rather than turn negative. "One of the reasons is that we don't have enough move-up properties for existing homeowners to trade up into." The Washington area also is likely to benefit from increased defense and government spending, offsetting the economic losses from layoffs and bankruptcies in the computer and high-tech industries in Northern Virginia and southern Maryland.