Kilroy Was Here
December 15, 2004
 
Trouble, Trouble, Boil, and Bubble
Matthew Yglesias examines the housing market.

Shifts in the fundamentals that increase home prices should increase rental prices proportionally, but buy prices have increased faster. If demand for home purchases is rising faster than demand for home rentals, it seems to me that that can only mean that people are buying houses as speculative commodities -- spending more than the house is really worth to them in the expectation that it's value will only increase in the future.

I agree completely. The Rent to Equity ratio of houses has rarely, if ever, been higher. Furthermore, the advent of ARM, interest-only, and no money down mortgages is significantly increasing speculation in the market. I have heard that as many as 15% of mortgages are risky and a spike in interest rates could result in significant sell off.

Furthermore, human bias's are fueling this binge. People tend to invest based upon the recent past, rather than the long term past. If you look at housing markets over the last 30 years, rather than the last 5-7 years, housing prices have rarely appreciated at a rate greater than inflation (California is CPI +2%, Oklahoma is CPI - 1.0%). However, in the hot markets (SF, NY, San Diego, etc.), the last 5-10 years have seen much higher returns. People tend to extrapolate from 5 rather than 30 years, and it gets them in trouble.

Second, as was brought up in MY's comments, real estate is really multiple markets, not one big market. Unfortunately, many people are taking the results in very land-restricted areas (SF, San Diego, Seattle, NYC) and applying those returns to places where land is cheap and development is easy (Henderson, NV, Phoenix, AZ, El Paso, TX, etc.) So a lot of folks are investing in real estate in places where the fundamentals are far worse than they're assuming.

I could go on and on. In summary, if you're looking to buy a place to live, real estate might be a good investment, but if you're looking at real estate as a speculative short term investment, or an investment who's income will cover the leverage you've placed yourself under, you're playing with fire.



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