Is a housing bust on the way? The question has a familiar ring. Since 2001 economists and journalists have with great regularity predicted an imminent crash in real estate prices, including a 2004 story in The New York Times with the headline "The Housing Bust: It Won't Be Pretty." Despite the predictions, however, home prices continued to rise, clocking in double-digit gains over the past two years.
Now it's my turn to take a whack at the housing piñata. I believe there's a good chance that real estate will follow a similar path as the stock and tech markets: a long boom followed by a decline of several years that gradually brings back values to the long-term trend.
If the housing market repeats this pattern, the result would be a slow-motion decline of 10% or so in national home prices, the equivalent of giving back a year or two of gains. Some regions, of course, would be hammered. A drop of this magnitude would be well worthy of the term "bust."
Especially hard hit will be recent buyers with a lot of debt as the drop in prices sends them, sadly, into the land of negative equity. Other homeowners would feel excruciating financial and psychological distress as paper gains melted away. Even the real winners -- people who formerly couldn't afford to purchase -- will feel anxious and paralyzed as home values fall.
Still, it's better to think of the housing bust as a return to normal rather than the end of the world. That's the lesson of the stock and tech crashes. For one thing, after a decade of boom, bust, and recovery, the Standard & Poor's (MHP ) 500-stock index today is 83% higher, adjusted for inflation, than it was in 1995. Thus, stock prices rose at an annual real rate of 6.3% over the past decade, just below the rate of the previous 15 years.
Or look at information technology spending by businesses. Despite the post-2000 tech bust, such purchases are 50% higher than in 1995, taking into account economywide inflation. That translates into an annual average sales gain of 4.3%, roughly the same growth rate as 1985 to 1995 and somewhat slower than the 15-year average.
If housing were to return to its long-term trendline, what would that mean for prices? Over the past five years home prices, adjusted for inflation, have risen at an extraordinary 6.8% annually, far higher than the historical 1%. To get values back on the long-term path would require a 20% drop in national home prices by 2010 in real terms. That's equivalent to a roughly 10% drop in the actual number of dollars buyers have to shell out.
A housing bust is hardly a sure thing. Asset markets -- and your home is certainly an asset -- are notoriously unpredictable. But whether you are a buyer or seller, it's worth taking the possibility seriously.
By Michael Mandel