The Real Estate Bubble and Nasty Popping Sounds: John Wasik
Personal Wealth
Fri, 27 Dec 2002, 11:31pm EST
The Real Estate Bubble and Nasty Popping Sounds: John Wasik
By John F. Wasik
Chicago, November 11 (Bloomberg) -- Now that the U.S. election is over, it's time to talk about something near and dear to the heart of most investors: real estate and debt.
Were you one of those investors who thought that during the height of the bear market residential real estate was a better investment than stocks, bonds and gold?
Were you heartened that the paralytic U.S. Congress did nothing to impact real estate prices and the Federal Reserve's 12 interest-rate cuts made it easier to buy and refinance real estate?
Despite all the upbeat real estate news, in some markets residential real estate is akin to the NASDAQ Index in March of 2000. It's ready to pop like a balloon hitting a hot light bulb.
First, the bad news and how it impacts real estate: If slack business and consumer spending drag the economy down further, it will depress real estate prices.
There are numerous signs that make residential real estate an especially dangerous investment now, although you can protect your net worth by taking a few precautions. First, you need to face some emerging facts.
The Economy and the Bubble
There's plenty of evidence to suggest that the U.S. hasn't climbed out of its economic crevasse.
As measured by the Gross Domestic Product, the U.S. economy rose at a 3.1 percent annual rate in the third quarter, according to the U.S. Commerce Department. A Bloomberg survey of economists had forecast 3.7 percent growth.
Add in declining factory orders and a nine-year low in consumer confidence, and you have some dark economic clouds moving in.
Translating macroeconomic trends to personal investment decisions is always nettlesome, though.
The key is remembering that real estate, like politics, is always a local matter. Some 7,600 job cuts a day were announced in October alone, according to the outplacement firm Challenger, Gray & Christmas.
If local employers are making substantial job cuts, that always has a strong impact on real estate. Large numbers of homeowners who have been unemployed for a year or more are likely to sell their homes, which will depress local residential prices.
Where the Bubble Will Burst
Finding what they believed was their ace in the hole, homeowners may have overinvested in local real estate in lieu of their sagging 401(k) stock plans. The result may be dozens of local price bubbles ready to burst.
Some guidance is provided by the Office of Federal Housing Enterprise Oversight, or OFHEO, an obscure U.S. agency that monitors the financial safety of the quasi-government loan corporations Freddie Mac and Fannie Mae.
An OFHEO survey covering U.S. home prices through June 30 found 20 markets with price increases ranging from 11 percent to 15 percent.
The top five markets were Yolo, California; Barnstable/ Yarmouth, Massachusetts; Santa Barbara, California; Nassau- Suffolk, New York; and Fort Lauderdale, Florida.
You can see the entire list at ofheo.gov in its ``Second Quarter 2002 House Price Index.''
Are these bubble markets? There are lots of other factors to consider, so the jury's still out.
The key to spotting a potential bubble involves common sense. Have real estate prices in your area risen much faster than area job growth, local corporate spending and the 6.48 annual home- price increase as measured by OFHEO?
Protecting Yourself
You can prepare yourself if a real-estate bubble is hovering over your neighborhood.
First, realize your home equity is a central part of your savings. You need to take steps to protect it:
-- Taking out equity gives you less leverage if you have to obtain a home-equity loan and raises your total debt payments. Say you have a $350,000, 30-year mortgage at 7.25 percent and refinance it at the same term at 6.25 percent. You take out 20 percent of your equity or $70,000. That raises the principal to $420,000. Over 30 years, you will be paying $71,422 more in total principal and interest payments, according to the Bloomberg.com mortgage calculator.
-- If you are buying a new property, remodeling or taking out cash after a refinancing, you need to keep an eye on local real estate trends. You may not want to invest -- or possibly sell --if you are seeing a slowing local economy.
Martin Weiss, president of Weiss Research, a consumer research firm, observes that real estate bubbles are most perilous to people living in areas where there's an imbalance between rising home prices and declining job markets.
``You'll see prices decline in bedroom communities where prices are most manic,'' he says.
It's All About Debt
Lower mortgage rates, ironically, pushed millions away from debt reduction and further into hock when they cashed out some $139 billion in equity during the past two years, according to Freddie Mac.
Paul Kasriel, chief of economic research for the Northern Trust Bank, notes that with household debt rising to post-war highs in the third quarter, millions of homeowners are stretched to the limit despite lower finance rates.
``The Federal Reserve encouraged people to go deeper into debt and invest in real estate,'' Kasriel said. ``Unless you can find a better investment than your home, just leave your equity alone.''
Reducing your real-estate debt gives you flexibility by allowing you to earn less income and be debt free at a younger age.
It doesn't matter what the new Congress will do to stimulate the economy because your personal debt holds much more sway over your life. All economy is local, particularly if it's yours.
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