Is A Real
Estate Bubble Forming in South Florida?
By Roy D. Oppenheim, Esquire
Connie Lewin
As interest
and mortgages rates begin to steadily rise, economic
analysts are reviving a debate of whether a bubble
is looming over the real estate (or housing) market.
A bubble, in real estate terms, is the point where
home prices are no longer sustainable, indicating that
the market is headed dramatically downward, usually
at least 10 percent.i
The bubble
argument rests on two main suppositions: the decline
in interest rates by the Federal Reserve inflated the
housing bubble, and subsequently, rising interest rates
will most likely burst the bubbleii ; the
other argument is that real estate speculation, driven
by low mortgage rates, has created an artificial demand
and home prices are thus poised for a decline.iii
Forecasting
whether a bubble exists and if it does, when the bubble
will burst is near impossible. Even so, the overheated
South Florida real estate market is raising concerns
that the market mania is reaching the unprecedented
rise and subsequent precipitous decline of tech stocks
at the turn of the millennium.
Demand is
still at an all-time high. According to the Florida
Association of Realtors, South Florida’s home
prices rose strongly over a 12-month period. Home prices
increased a whopping 26.8% in Fort Lauderdale from
$220,000 to $279,000; 25.8% in Miami from $216,000.00
to $271,900.00 and 25.8% in Palm Beach County from
$233,600.00 to $294,100.00. The figures are based on
the number of second quarter median sales in the area
from April 2003 to April 2004. Real estate professionals
are crediting low mortgage rates to the heated rise
of home prices, driving would-be buyers to deciding
and biding quickly and furiously.
Real estate
is also a hot market for investors as well. The downturn
in stock values has prompted investors to literally
bank on the robust real estate market for high returns.
Both local brokers and brokers from Latin America are
attracting potential investors to South Florida with
preconstruction investing into condominiums with the
promise of returns as high as 100% per year…sometimes
more.
Indeed,
many of these investors have no intention of ever living
in the units they buy; instead, they look for rental
income or are more likely to resell their units for
a profit.iv Both the New York Times and
Associated Press have noted the increasing trend in
house flipping, investors solely buying homes that
they can “flip” for a quick sale and a
big profit.
It is these
speculative buyers that analysts accuse of being culprits
since they are creating an artificial demand for condominiums
and homes that will quickly vanish as soon as mortgage
rates and interest rates increase. Many of these buyers
and investors are buying simply due to rising prices
instead of for intrinsic value, such as one’s
desire to use the property for oneself.
Secondly,
the high price jumps of homes have risen faster than
incomes. In a recently released report from HSBC, entitled
The U.S. Housing Bubble — The case for a home-brewed
hangover, HSBC chief U.S. economist Ian Morris found
that house prices relative to income, rent, replacement-cost
and home-equity is reaching record highs. Home prices,
he warned, could decline by 5 percent to 10 percent
nationally over the next five years. “Expectations
of future house price appreciation are spectacularly,
and unrealistically high,” he said.v
The decline
in rent-to-price ratio also signals to some economists
that a bubble is looming. Dean Baker, co-director of
the Center for Economic and Policy Research, argues
that if home prices are at a higher rate than rental
prices and inflation, a bubble must be looming. If
a growing population and a limited supply of homes
are causing the increase in home prices, rental prices
should also be roughly the same amount as home prices.
Rental prices, however, are at a standstill and are
not appreciating at the same rate as home prices.vi
Rising mortgage
rates can also impact the housing market since they
make homes less affordable, which can hurt selling
prices. Analysts at Business Week Online found that
if 30-year fixed-rate mortgages rise just one percentage
point, to 7.2% from their current 6.2% -- well within
the range of forecasts -- house prices would have to
fall 11% to keep new buyers' monthly mortgage payments
from rising. If fixed rates went to 8%, prices would
need to fall 20% to keep payments level.vii
Mortgage debt has also risen faster than home values
since 2000, according to Federal Reserve data. Many
analysts argue that it is the relationship between
interest and mortgage rates that inflate and deflate
the real estate bubble.
If the real
estate bubble exists, experts argue, its explosion
could also greatly impact the economy. Goldman Sachs
economist Jan Hatzius argues that a decline in housing
reduces consumer spending at least as twice as much
as a same-sized loss in the stock market.viii
Optimists
of the real estate market, on the other hand, downplay
the danger of a bubble, by pointing to the fact that
despite the increase in interest rates, mortgage rates
remain at a record low and the tight supply of homes
for sale has helped to boost demand. Some economists
also argue that rising interest rates are an indicator
of the health of our economy.
"The
reason interest rates are higher is that we are in
a growing economy," said NAR chief economist David
Lereah in a recent release. The opinion is that rising
salaries and stock market returns can create enough
wealth to offset the negative effects of rising mortgage
rates.ix
Optimists
of the real estate market also point to the government’s
campaign to boost the rate of home ownership. The government
introduced initiatives to boost the rate of house ownership
with tax incentives and the private sector has responded
too, with increased competition in mortgage lending
in the past decade.x
Economists
at the Federal Reserve have also disputed the bubble
theory. A recent 12-page report titled, “Are
Home Prices the Next ‘Bubble’?” by
Jonathan McCarthy, a senior economist, and Richard
W. Peach, a vice-president, at the Federal Reserve
Bank of New York, reached the conclusion that “the
most widely cited evidence of a bubble is not persuasive
because it fails to account for developments in the
housing market over the past decade. In particular,
significant declines in nominal mortgage interest rates
and demographic forces have supported housing demand,
home construction, and home values during this period.
Taking these factors into account, we argue that market
fundamentals are sufficiently strong to explain the
recent path of home prices and support our view that
a bubble does not exist."xi
The report
attributes the rise in home prices to inflation, but
more significantly to the changing demands and tastes
of home buyers. In addition, mortgage rates are still
at a record low. It is demand that is causing rising
home rates.
According
to Freddie Mac, a federal mortgage corporation, fear
of a real estate bubble is unwarranted because the
housing market does not exhibit the boom and bust traits
of an economic bubble. Amy Crew Cutts, deputy economist
at Freddie Mac, points to the fact that housing costs
are high, holding time is quite long, and most people
buy homes for consumption, not investment. Cutts argues
that prices in the real estate market are rational
since they reflect current economic conditions.xii
For South
Florida, then, the real estate market reflects both
investor enthusiasm and enthusiasm for home ownership
with new demands coming from the climatic and multicultural
attributes of the region. There remains an unwavering
demand for South Florida housing, with unprecedented
growth in Palm Beach County and steady growth in both
Fort Lauderdale and Miami. South Florida continues
to attract new residents from Canada, the Northeastern
U.S., Latin America and Europe, and that high demand
is outpacing new construction, creating unbelievably
a housing shortage. Although there are many buyers
seeking to flip homes for high returns, there are equally
as many South Florida buyers looking for places to
live and are taking advantage of the currently low
mortgage rates.
Therefore,
while experts are split on whether a housing bubble
exists in the United States, for South Florida the
soaring demand and drop in inventory suggests that
home prices will continue to remain strong. Prices
may dip or not continue their immediate escalation,
one thing is certain, that long-term, real estate is
still your best investment. According to the Florida
Association of Realtors, the median price of a resale
home in Florida has jumped more than 51% over the past
five years.xiii Demand might cool with rate
increases, but buyers are still willing to shell out
for the high prices of homes.
Advice for
new buyers is to spend only what you can afford, use
home equity with care and do not plan to buy a house
if you do not plan to live there for a few years. If
you are a “Flipper,” be ready to close
on the property and rent out the place for a few years
if you are unable to sell. Otherwise, be ready to walk
away from your Real Estate Deposit.
Real estate
investing is really just like musical chairs; when
the music stops, and it will, because it always does,
will you be left standing out in the cold?
Roy D.
Oppenheim, a well respected Real Estate attorney and
consumer advocate, is President of Weston Title and
Escrow, Inc. Mr. Oppenheim actively invests in Real
Estate and represents clients concerning their Real
Estate investments.
Connie
Lewin is a senior at Princeton University majoring
in Comparative Political Systems and is an active member
of the Whig-Cliosophic Society.
Copyright
Weston Title & Escrow 2004
i
http://www.nctimes.com/articles/2004/08/15/news/californian/20_21_148_14_04.txt
ii http://www.businessweek.com/magazine/content/04_29/b3892064_mz011.htm
iii http://quote.bloomberg.com/apps/news?
pid=10000039&refer=columnist_wasik&sid=aDX8ADXYd6iE
iv http://www.miami.com/mld/miamiherald/business/8405214.htm
v Reuters. “HSBC, unlike Fed, sees
U.S. housing bubble.” USATODAY.COM. 25 June 2004.
< http://www.usatoday.com/money/economy/housing/2004-06-25-housing-bubble_x.htm>
vi Baker, Dean. “Who to Blame When
the Next Bubble Bursts.”
<http://www.cepr.net/columns/baker/next_bubble_bursts.htm>
vii http://www.businessweek.com/magazine/content/04_29/b3892064_mz011.htm
viii http://biz.yahoo.com/bizwk/040709/b3892064mz011_1.html
ix Max, Sarah. “What do rising rates
mean for housing?” CNNMoney.com. 27 July 2004,
< http://money.cnn.com/2004/07/13/real_estate/buying_selling/risingrates/>
x Croke, Hilary. “The Run-Up in Housing
Prices is Not a Bubble.”
Center for Economic and Policy Research. <http://www.cepr.net/columns/housing_bubble/no_housing
bubble.htm>
xi McCarthy, Jonathan and Richard W. Peach.
“Are Home Prices the Next ‘Bubble”?”
FRBNY Economic
Review/Forthcoming. < http://www.ny.frb.org/research/epr/forthcoming/mccarthy.pdf>
xii “Freddie Mac: No Housing Bubble”
http://www.fool.com/news/commentary/2004/commentary04073003.htm
xiii “Freddie Mac: No Housing Bubble”
http://www.fool.com/news/commentary/2004/commentary04073003.htm
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