IF YOU'RE ASSOCIATED WITH HOME BUILDING, then chances are good you've been quizzed recently about the newest hot topic: Are we on the verge of a housing bubble pop? In September, Fortune said so, citing data that show housing prices increases out of line with increases in income and rent and contending that home prices in some locales are significantly overvalued. The magazine warned that we can look forward to those prices falling flat or, in some cases, plummeting.
There's no denying that home prices have jumped. The house price index tracked by the Office of Federal Housing Enterprise Oversight showed a 9.36 percent hike between the second quarters of 2003 and 2004, the greatest rate of appreciation in 25 years.
But many economists and housing analysts dismiss the bubble theory. They agree that appreciation will slow in coming years—and, in a few markets, may flatten or even dip negatively—but they argue that the basic tenets of supply and demand will continue to support a strong housing market. A crash, they say, isn't on the way.
“A bubble is something that cannot be explained by market fundamentals,” says Amy Crews Cutts, Freddie Mac's deputy chief economist. The tech bubble of the late 1990s, she says, was based on people buying stock for the chance that those companies could be the next Microsoft, without regard for missing business plans. “It's a mentality that it's a lottery. But that's not why people buy houses,” she says.
Some fear speculators—those buying homes just to flip them—have expanded the bubble to its limit. Speculation is more common in some markets than it was five years ago, says Nicolas Retsinas, director of Harvard University's Joint Center for Housing Studies, but he doubts that it will lead to problems nationwide. “People aren't going to day trade their homes,” he says, adding that the process of buying and selling is still complicated enough to dissuade flipping on a grand scale.
David Seiders, chief economist for the NAHB, refutes some of the data that has been used to bolster the bubble theory, particularly the rising ratios of house prices to household income and rents. Those data, he argues, fail to account for the effect historically low interest rates have had on the affordability of monthly mortgage payments. (For more of Seiders' opinions on the bubble, please read “On the Rise,” page 82.)
Forecasts for the sector's underlying fundamentals—household growth, land constraints, and job growth—also counter the bubble theory. Those pieces would all have to falter for home prices to fall 5 percent to 10 percent—a highly unlikely event, says Tim Sullivan, principal of Hanley Wood Market Intelligence (formerly the Meyers Group, and recently purchased by Hanley Wood, LLC, publisher of Builder). In fact, the Joint Center for Housing Studies revised its household growth rate upward this year; it now projects 13.3 million new households during the next decade.
What's more, in the 44 years national home prices have been tracked, there's never been a year-over-year decrease. A few markets—Southern California and Houston, for example—saw prices tumble in the late '80s and early '90s due to severe job losses.
Crews Cutts doesn't expect that again in California, but she says the loss of manufacturing jobs in the Midwest does put some markets at risk today. “When there are no jobs, people start to leave,” she says. “When there's nobody moving in, there's nobody to buy the houses, and that drags prices down.”
But Crews Cutts is encouraged by the changes in home building since the early 1990s, including the increased use of land options and less spec building. “Builders can regulate supply in markets that don't need it,” she says. “As soon as the demand falls off, they will put down their hammers. There's discipline in the building market that wasn't there the last time.”