Bubble trouble?
The red-hot housing market reminds some of the latter days of the 1990s stock market. How will it end?
That may be true. But a lack of available housing didn't stop real-estate prices from plummeting there amid the economic downturn that followed the 1987 stock market crash. That's when Sheryl Lieberman bought her first apartment in Manhattan for $230,000. Six years later, a friend in the same building sold a similar apartment. "It was two flights higher, so it should have been worth more than my place. But she only got $160,000," recalls the 45-year-old financial adviser. "People forget that what goes up can also come down. Like right now, they think real estate can't fail. I heard the same thing in the early 1980s, and then came the late 1980s."
Convinced the New York City market is overpriced, she recently decided to sell the apartment where she now lives on Midtown's Sutton Place and rent for a while. "I may not be selling at the top of the market," she says of the sum she received, which is nonetheless about triple what she paid for the apartment in 1996. "But as inflation picks up, you'll see interest rates go up, too. And as a direct result, real-estate prices are going to go down."
Lieberman doesn't expect an outright crash in the market. "But having been an investment professional for the past 23 years, I've seen the cycles come and go," she says. "And we're near the end of one now."
Predicting exactly when a financial bubble will burst is next to impossible. That's partly because it's so hard to account for the vagaries of human psychology: how greedy will people get (usually, more than anyone expects) and what will it take to make them panic (often, far less than is rational). Yet there is mounting evidence that things are getting out of whack. In addition to buyers' increasingly unrealistic expectations of appreciation, one worrisome sign is the surging gap between housing price increases and growth in personal income.
Trusty real estate. Until recently, the run-up in housing prices roughly tracked increases in personal income. But that relationship, long considered a bellwether for judging housing affordability, began to change a few years ago as the recession put a lid on workers' salary increases yet failed to dampen their demand for homes. Burned by the stock market debacle, many Americans turned to real estate as a safe investment. Even if a home wasn't the "next big thing," at least it wouldn't turn into a worthless scrap of paper. Buyers were enabled, in part, by record low interest rates and a growing menu of adjustable-rate and interest-only mortgages that allowed people like Wu and Koder to purchase their first homes, while giving existing homeowners the buying power to trade up. Low home equity loan rates, too, sent others on a remodeling binge that may have increased their homes' values but put them further in debt.
For much of the past 30 years, median home prices in the United States remained between 2.7 and 2.9 times Americans' median household income. In other words, if you spent every dime you earned to pay off your house (not including interest), you'd do it in about three years. But starting in 2000, that ratio began climbing to about 3.4 times personal income. In relatively subdued markets like Pittsburgh and Milwaukee, it remains closer to the historic norm. In the hot markets like San Diego, however, where prices have doubled since 2000 while income has increased by only 10 percent, the cost of houses approaches 10 times what buyers earn each year.
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