Is It a Bubble If It Never Pops?

The enduring strength of the housing market is confounding the conventional wisdom and may keep doing so for quite a while

By Amey Stone

So much for the housing bubble. As overheated as the real estate market may seem in certain parts of the country, it has thus far defied expectations of slowing down on a national level, let alone popping like a balloon. Most measures of housing activity -- from average sale prices to existing home sales to new residential construction -- are at or near record levels, even as mortgage rates have ticked up.

In June some housing data, along with a slew of other indicators, showed signs of slowing. But the Aug. 17 report on July housing starts pretty much dispensed with concern for the time being. They jumped 8.3% in the month, more than making up for June's 7.7% drop, according to the Commerce Dept. Residential units are being constructed at an annual pace that remains near a 2 million clip, just a slight dip from the record 2.067 million annual rate of December, 2003.

"It is now clear that the June drop in starts was an aberration," concludes research firm ActionEconomics. Mike Englund, its chief economist, now expects July figures on new and existing home sales, due out later in August, to be strong as well.


  Despite a flattening in prices at the highest levels in the past year, the median home price has also kept climbing. On July 26 the National Association of Realtors (NAR) reported that the median sale price of a single-family home rose to a record $191,800 in June, 10% higher than the prior year. And on Aug. 9 the NAR upped its forecast for 2004 home sales to a record 6.45 million, up from 6.1 million in 2003.

"The bottom line is that mortgage interest rates have been lower than expected, the economy is improving, and jobs are being created in an environment of strong housing demand -- all favorable factors for record home sales," said NAR Chief Economist David Lereah in the release.

Earlier in the year the expectation was that mortgage rates would rise sharply in 2004, but that hasn't been the case. Even though 30-year loans are likely to average about 6.1% in 2004, up from 5.8% in 2003, that's still very low by historical standards. And home buyers who can't afford those rates have been able to jump into adjustable mortgages. Some housing experts believe rates would have to rise above 8% for the housing market to stumble.


  On the supply side, homes available for sale nationwide remain at a record low inventory of just 4.1 months, according to the NAR. "Until the supply goes up, the increase in price is rational," says Prakash Dheeriya, a finance professor at California State University at Dominguez Hills, who's studying the Southern California real estate market.

Many bubble theorists worry that a flood of new homes will come up for sale at the first sign of weakness in home prices, crushing the market. But Dheeriya says his research shows prices won't drop suddenly even if mortgage rates climb, primarily because sellers who were trying to get out at the top of the market have already done so. "I don't think there can be a sudden onslaught of supply," he says.

That doesn't mean the housing market couldn't slow from here -- or that prices can't fall in some select areas. Dean Baker, co-director of the Center for Economic & Policy Research, points to a glut in rental housing, especially in some overheated markets like Seattle and San Francisco. If rental rates remain flat or decline while prices for comparable homes continue to rise, that will take the air out of the housing market.

"Eventually people will start saying that it's foolish to buy a home when you could rent instead," he says. He also thinks mortgage rates will rise in the next year to levels that will preclude many families from trading up to a bigger home.


  Mike Sklarz, chief valuation officer at Fidelity National Information Solutions, which provides real estate pricing tools to lenders, already sees some subtle signs of slowing -- such as a leveling off in home prices above $500,000 in many markets. He's hearing a lot more anecodotes of "for sale" signs going up in pricey neighborhoods, signaling that not enough affluent buyers may be available for all the high-end homes being built. "Overall, however, inventories are still at incredibly low levels, and this is not the kind of thing that can turn on a dime," says Sklarz.

The best hope of many economists is that the housing market will gradually cool down, preventing too many mini-bubbles from building up in overheated real estate markets around the country. In that sense, a few years of slower home-price appreciation would be welcome. But with supplies tight, and plenty of buyers able to afford homes, that's not even beginning to happen yet.

Stone is a senior writer for BusinessWeek Online in New York

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