Just last week I was talking with a few people about the state of the real estate market in the U.S. One friend, who is a neurosurgeon in Pasadena, mentioned that a lady in his office had recently sold her 1800 square foot home in a decent school district for $530K, which was $50K more than she had asked for. He mentioned that you can’t buy a house these days in that area at the ask price; you have to pay at least 5 – 10% more. Another friend concurred, saying his neighbours of two years had recently moved after someone knocked on their door and offered $75K more than what they had paid for their home. When the housing market heats up that much, at a time when the unemployment rate is hovering near its highest levels in eight years, the stock markets have crashed, and the dollar is sinking, its time to be cautious about real estate.
Several weeks ago I mentioned that I have invested in real estate as part of my retirement plan. I then got a few email from readers saying they were also enthusiastically buying real estate. It occurred to me that a word of caution may be in order.
Yes, we are undeniably in the midst of a housing boom in the U.S. This year we've seen the four highest monthly sales rates on record for existing-home sales, and prices are soaring. The National Association of Realtors reported that average house prices rose roughly 9% in April from a year ago, the largest year-to-year gain in more than a decade. In the hottest markets, including New York, Florida, California, and the Greater Washington, D.C area, that number is much higher.
Many experts are agreeing however that we may very well be in the last stages of a real estate bubble. There are a lot of reasons to believe that this boom can’t last much longer, and there is a lot of evidence mounting that the real estate market may already be beginning to turn.
For those who have bought real estate as an investment, this could mean a simple rotation may be in order. As the stock market began crashing, many investors began pulling out and looking for safer havens. With the low interest rates and booming housing market, for many that has been real estate. One has to wonder though, with the market bottoming and the recent attention to a potential real estate bubble, if we won’t again see a rotation back into stocks. Any increase in interest rates would certainly encourage that trend, and the sudden supply in housing would work to drive prices lower.
What I have invested in are lower-priced rural and resort properties. My reasoning was that, if it is true that we Baby Boomers are moving into our later years as hopelessly unprepared as the statistics would make it seem, we will be looking to cash out of our higher-priced homes. For many, our only real investment in life has been our homes. So as we retire and realize we don’t have as much as we need, I feel many will be looking for comfortable, cheaper places to live. I may be dead on about this, or I may be full of dog doo, but that’s my plan in any case.
For families buying homes however, the situation is much more serious. Many families have been put in a rough situation here. Prices may continue up from here, we really don’t know. So do they take advantage of the low interest rates, buy here, and risk getting in at the top? In that case they may wind up a few years down the road owing more for their homes than they are worth. Or should they wait for prices to come down? If they never do come down, they run the risk of the market moving too far out of their reach, and may never be able to afford a home. My daughter is in Silicon Valley now facing this same issue.
The situation seems very fragile. Millions of families have already gotten in over their heads. According to the National Association of Realtors, many lenders are allowing monthly mortgage payments as high as 42% of the borrower's income. The average down payment has also dropped in the last ten years from 10% to 3%. Interest-only loans are becoming increasingly common. So we have millions of families working themselves to the bone, earning no equity, and only one or two missed pay-checks away from disaster.
Obviously the implications of this on our economy could be horrific. Up to now the blow of the crashing stock market has been cushioned by the housing market. According to the Federal Reserve, home values have double the impact on consumer spending that stock values have. So the housing bubble is keeping our economy afloat thus far. But what happens when Mr. Greenspan finally raises interest rates?
For those who are already struggling to hold their heads above water, with an adjustable rate loan, an increase in rates may push them under. For new buyers, higher rates in an inflated market may keep them from ever realizing the American dream. Its an accident waiting to happen.
So what am I saying here? I am urging you to be careful, and be aware. Taking advantage of a low fixed rate on a home you plan to live in for the next 20 years may be wise. Your home is a completely different situation from a mere investment. But think twice about what you can truly afford, and don’t get in over your head. Do your research. Know your local real estate market, and know your local jobs market. Know what your goals are, and think about the long term. Have a nice week! And by the way, for anyone following along, I sold my LNY Friday.