Is there a housing "bubble," in which prices are unsustainably high? The simple answer is: hell yes!
This edition of Money Sunday focuses on the housing bubble: evidence for this phenomenon and, more importantly, what you can do to protect yourself in case the bubble bursts....
First of all, a housing "bubble" is merely a specific form of a more general economic phenomenon: something called a "speculative bubble." Some economists believe that, in certain markets, buyers bid up prices to irrational levels that are not grounded in principles of economic value. Exactly why this phenomenon occurs is the subject of ample debate, but it seems that bubbles occur when investors use price itself as information about markets. If prices are climbing, buyers reason, there's profit to be made by selling to the next buyer in line — as inevitably there will be if prices are rising. (Wash, rinse, repeat.)
This buyer behavior works if everybody thinks the same way. And for some time many people do follow the herd, bidding up prices in a continuous frenzy. But the bubble eventually bursts when there are no more gullible buyers left to join the herd. That's when owners suddenly turn into paupers.
Forbes Magazine recently wrote about how much one million dollars buys in the residential housing market. The answer: not nearly as much as it used to. (Forbes's sample properties demonstrate just how ridiculous housing prices are.) Economists take a more precise view than Forbes does by comparing housing prices to rental rates (intra-market comparisons) and by comparing housing prices to personal incomes. There, too, all evidence points to an overheated housing market. Quite simply there aren't enough high income earners to sustain these price levels in most housing markets around the country.
To burst any bubble some event needs to take place. How violently the bubble bursts will depend on how far advanced the bubble is and how big the external event is that causes the burst. Trigger events might include a recession (with new job and income loss) and/or inflation (with its inevitable interest rate hikes). These events now look likely.
It should be noted that past real estate booms have generally followed a stair-step pattern, with prices surging ahead for a while then holding steady then surging ahead again. Hopefully that's the case this time, but it's hard to remember a market as overheated as this one.
What To Do
- If you haven't done so already, lock in a fixed mortgage rate. Mortgage rates are still near their all-time lows. Fixing your mortgage rate and payments will give you predictability in your household budget.
- If you are one of the many Americans who is overextended in your housing -- with a mortgage payment that would be unsustainable with even a minor hiccup in your household income -- now's the time to downsize. Consider taking your profits and renting until the market cools off, especially if you aren't sure if you're going to stay in your house for 5 years or more.
- Avoid purchasing a home now unless you absolutely must. Rent and save instead -- and stick to that savings plan zealously.
Got any more ideas about dealing with this housing bubble? Please post your thoughts.
And that's Money Sunday for this Mother's Day. Be sure to read past editions: