A friend recently supplied troubling evidence of the “real estate bubble.” In her experience, the bubble is real ? and it just burst.
Like many, my friend watched the value of her home between Baltimore and Washington appreciate to stratospheric levels in recent years.
She decided to sell it and buy a dream house in a new development in Pennsylvania.
She cleverly made the purchase contingent on selling her old home ? which turned out to be a problem.
When no buyers approached her at the original price, she shaved $40,000 from it.
Still no taker.
The wait made the builder of the new development nervous. Turns out a half-dozen of his buyers sat in a similar predicament. To help close on his homes the developer told them he would trim $40,000 from sale prices if they discounted their old homes the same amount.
Of course, this could be an isolated anecdote. Real estate professionals have dismissed a bubble for some time.
Just last month a survey of Baltimore and Washington builders, appraisers and brokers conducted by the Edward St. John Real Estate Department of Johns Hopkins University, reiterated the pros? rosy outlook.
It argued the area?s strong fundamentals might lead to more moderate price increases, but no bursting bubble.
We heard the same happy-talk from stockbrokers before the tech meltdown in 2000.
The fundamentals suggest others will likely share my friend?s trauma ? and soon.
Prices in any market start to fall when supply outpaces demand and inventories increase.
That?s exactly what?s happening in housing: Nationwide, the inventory of unsold homes is up almost 40 percent from a year ago, sitting at its highest level in nine years, according to Merrill Lynch economist David Rosenberg.
Since Baltimore politicians and development officials crow so loudly about the city?s condo-building boom, it?s worth noting that this sector seems primed for the steepest fall: Nationally, there?s an all-time record eight months of unsold condo inventory. That?s up from 3.1 months in June 2004, and exceeds the current 6.1 month supply of new homes and 6.8 month supply of existing homes. Condo sales have fallen 15 percent over the last year.
Oversupply is just one part of the picture, however.
Those who used adjustable-rate or interest-only mortgages to buy into the bubble are now finding that rising interest rates stretch their budgets to the breaking point.
Housing market monitor RealtyTrac recently announced that the number of U.S. households falling behind on their mortgage payments rose 25 percent this spring.
“Somewhere north of $2 trillion in adjustable-rate mortgages are due to reset,” says RealtyTrac?s Rick Sharga.
“What these people are looking at is a 20 percent to 50 percent jump in their monthly bill ?that, on top of rising energy costs and credit card bills. We expect foreclosures are going to go up steadily throughout 2006 and probably into 2007.”
All this could slow the U.S. economy considerably.
Federal Reserve Board research shows that we spend up to 6 percent of each extra dollar of home equity annually on clothes, cars, travel, and other fun stuff.
If, as Dean Baker of the Center for Economic and Policy Research in Washington estimates, the housing bubble created $5 trillion in illusory wealth, and if it all goes away, that would cause a $300 billion annual decline in consumer spending.
If you think that?s small change, note that it surpasses by 50 percent the combined Bush tax cuts of 2001-03 (in inflation-adjusted dollars).
So, as my friend learned, we live instressful times.
Hopefully, a couple of years from now, we won?t look back on the summer of 2006 the way tech investors look back to Spring of 2000.
Right now, though, I wouldn?t bet the mortgage on it.
Steve Walters is a professor of economics at Loyola College in Maryland. Contact him at [email protected].
