Real Estate Bubbles
In many cities across the US we now see skyrocketing real estate prices. This is most evident in mature cities such as NYC, San Francisco and Boston. A quick search on realtor.com will show that many of these places are over $600,000 for a small home.
Other cities as well have seen big increases in price. Las Vegas, NV for instance has houses go from around $170,000 to $285,000 in a little more than a year.
The cause of these rapid increases has to do with low interest rates. Mortgage rates are at lowest levels we have seen in decades. All of this means lower borrowing costs and higher demand for houses.
The problem, is in many places housing prices have risen faster than income growth. And the benefit of lower interest rates is no longer relevant to new home buyers. Here is an example:
$165,000 House in Higher interest rate environment:
Interest rate 7.25% Monthly payment (Principal & Interest) = $1125
$285,000 Same house approx 1.5years later
Interest rate 5.25% Monthly payment (Principal & Interest) = $1573
So, as you can see, the interest rates are no longer much of a benefit when prices of homes go up so much as to outstrip benefit of lower rates.
And, costs may be even much higher than $1573 because as price of house goes up, affordability goes down. Homebuyer may not be able to make necessary down payment to eliminate private mortgage insurance. This may mean an extra $100 or more a month for this which is not tax deductible.
Interest rates will eventually drop, and when they do, demand for homes will go down and will put downward pressure on housing prices.
Some other factors that may put downward pressure on prices is weak economy. If jobless rate goes up, many people may be forced to sell homes and move into lower priced areas. Also, the fact that prices have gone up so greatly has led to many people purchasing second or third homes for investment. This could result in overcapacity and thus; put downward pressure on price.
The uncertain factor effecting housing prices is baby boomers. Many of them are retiring soon and may relocate to new areas and purchase new homes. These people retiring will effect the housing market. They will put upward pressure on housing prices in certain areas, but may put downward pressure on places they are moving from.
Looking further into the future, some other uncertainties that may effect housing market is Socal Security and Medicare. Currently, it takes over 3 workers to support one retiree. This trend cannot continue and will result in cut in payments to retirees or increase in taxes. These changes in incomes/taxes in uncertain ways.
The baby boomer population made up 27% of US population in 2003. They are aged 39-57 years old as of 2003. The total US baby boomer population is 77 million.
Housing prices cannot rise much more than inflation over a long period of time for most markets. People have to be able to afford housing and meet monthly payments. When prices increase faster than inflation over period of time, we know that this cannot continue forever. As we have seen in the stock market, it looks like we will see that in real estate markets.
Sources: Fortune, The $44 Trillion Abyss Nov 24, 2003 119
http://www.metlife.com/WPSAssets/19506845461045242298V1FBoomer%20Profile%202003.pdf
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