Fall Real Estate 2005

Publication Date: Wednesday, October 12, 2005

Bubble? What bubble?
Real estate economist says don't fear a housing market bust

by Andrea Gemmet

The distinction between balloons and bubbles -- two kinds of fragile spheres puffed up with air -- could not be more important when it comes to describing the Bay Area residential real estate market, according to David Lereah.

David Lereah, the chief economist for the National Association of Realtors, says the booming local real estate market is fundamentally sound.

Lereah, the chief economist for the National Association of Realtors, said that despite the gloom-and-doom headlines in the national news, the local market is not a real estate bubble about to pop.

Instead, he likened it to a balloon, and predicted that while some air -- in the form of a slower rate of price increases -- is going to leak out of the balloon, it is not going to burst. Prices won't drop, and the market won't collapse, he said.

His message of good news, tempered with some key caveats, was received with enthusiasm by a crowd of about 400 real estate agents at an event hosted by Opes Advisers at the Palo Alto Hills Golf and Country Club on Sept. 15.

The market is fundamentally sound, although he said that people couldn't expect double-digit price appreciation to continue forever. Looking forward to 2006 and beyond, home prices will continue to appreciate, he said, but at a slower rate. Even if prices dip slightly, they will bounce right back, he said.

"The good news for housing is that it will be a soft landing," he said.

One of the things that keeps the local real estate market more stable than, say, the current condominium-frenzied market in Miami, is the fact that most Bay Area owners buy homes to live in. Investors speculating in real estate are much more likely to get out if prices drop, but homeowners are going to ride out any dips in the market, he said.

"If your next-door neighbor lists his home for $1 million and only gets $900,000 for it, are you going to immediately put your house up for sale?" he asked rhetorically.

However, Lereah said he was concerned by the popularity of adjustable rate (ARMs) and interest-only mortgages, especially since they are so prevalent in the Bay Area. When interest rates inevitably rise, a lot of homeowners could find themselves unable to make their monthly payments, and the rate of delinquent payments and foreclosures will rise, he said.

"That's the biggest risk in the market today, period. That's what is different in the market from five years ago," Lereah said. "Today, a lot of people don't know what a double-digit interest rate is."

He predicts that when mortgage interest rates rise to 8 percent, the "you-know-what will hit the fan" in the rest of the country, but for the Bay Area, it will be a problem when rates rise to 7 percent.

There are a couple of other exceptions to his rosy predictions for real estate -- the commercial real estate and luxury home markets are much more volatile than the residential market.

"If you've got a real luxury home, you're taking a risk no matter what," he said. "For $10 million homes, there's a small supply and a small demand."

He also counseled caution about investing in real estate investment trusts (REITs).

"Be very careful, because most of them are dominated by commercial, not residential, properties. The boom is residential," Lereah said. "The commercial market dances to a different tune."

According to his research, the current real estate boom started in 1992, and it's being driven by more than just low interest rates. The biggest factor is demographic trends, he said. Baby boomers are in their peak earning years and, since the early 1990s, they've been spending money like there's no tomorrow, he said.

Not only have boomers been buying second and third homes, but they are also living longer than previous generations and staying in their homes longer, which reduces the housing supply.

Adding to the demand for housing is the record number of people who immigrated to the United States in the 1970s and 1980s. They began buying homes in the 1990s, and the ones who arrived in the 1990s are buying now, thanks to a drive to increase minority homeownership. On top of that, the children of baby boomers are entering the housing market, he said.

Other factors include improvements in technology that have reduced the cost associated with real estate transactions, and economic uncertainty that makes real estate seem like a safe haven compared with other investments, Lereah said.

In the Bay Area specifically, the housing supply is lean, jobs are coming back to the area and new housing construction is low -- all factors that will keep real estate prices high, he said.

"This is not irrational exuberance," he said.

When questioned about the impact of the war in Iraq, Hurricane Katrina and high oil prices, Lereah said, "I hate to say it, but housing is a beneficiary of low economic growth and unemployment. It keeps (interest) rates down."

Lereah serves as NAR's spokesman on economic and policy issues and trends affecting housing markets and real estate industry. His book, "Are You Missing the Real Estate Boom?" was recently published. Prior to joining NAR, he was chief economist for the Mortgage Bankers Association of America.

Andrea Gemmet is a staff writer at The Almanac. She can be reached at agemmet@almanacnews.com.