Room With A View, Or Deja Vu?

Patiently ticking off a list of reasons for my doubts, I concluded the conversation feeling that my words fell on ears more used to ignoring the facts. Real estate, after all, is different from equities. People live and work on their physical properties, and over the long run, owning real estate has always proved rewarding. Besides, with immigration into the US on the rise, demographics point to heightened, continuing demand for housing.

IS IT A BUBBLE?

With few variations, these are the types of arguments that prevailed during the stock market bubble. Now, disgusted with the stock market's performance, investors are increasingly tossing their funds into real estate. Stories about people buying second and fixer-upper homes abound. Just last week, a client who is remodeling her home told me about a real estate agent who purchased a house three doors down from hers. Over the next three months he put $30,000 into remodeling it, then put it back on the market. Three days later it sold for $10,000 more than his asking price — and he pocketed a swift $90,000 profit.

Other clients have revealed how they showed up one day after a home came on the market and discovered as many as 11 offers ahead of theirs. Granted, this is California, long known for its skyhigh real estate prices and demand for affordable housing. But we've been tracking similar stories from other cities all around the United States.

If Alan Greenspan contributed to the equity bubble with his easy-money policies, and many believe he did, the housing market has remained one of his primary tools to keep the economy from following Wile E. Coyote over the nearest cliff. Mortgage rates have been dropping steadily to 40-year lows, and are currently under the 6% level. Greenspan has used housing to influence the all-important yet occasionally timid consumer, who many fear may pull a disappearing act if things get much dicier.

THE UNDERLYING BASICS

According to data from the US Department of Commerce, in 1994 Americans were saving approximately 6.1% of their disposable income. By September 2000, a full six months after the stock market peaked, the savings rate had evaporated to 0.4% of disposable income. If the booming stock market, by Greenspan's own account, bolstered economic growth as much as 1% annually, the need to keep the upward pressure on real estate prices could continue for a while. And that's the key — "a while." If rising stock prices lent comfort to those who saved less, it simply doesn't follow that falling equity prices will accelerate the trend.

Three years ago, at the peak of the equity madness, Paul Volcker, Greenspan's predecessor, made what many at the time viewed as a prediction. Volcker pointed out that the world depended on the US economy, which depended on the stock market, which depended on roughly 50 stocks, half of which had never reported any earnings. Whether investors realized at the time that Volcker was talking about the global balance sheet is moot. As the ugliness increases, however, investors are starting to get it. According to the The Wall Street Journal, investors yanked more than $18 billion out of equity mutual funds in June, the third largest total monthly redemption ever.

Basic psychology teaches us that people are not much different from each other. If people discover their friends are making money in the real estate market, they tend to follow. The bubble that built up around the Internet craze is a classic example. Nor should investors expect the so-called experts, those people who primarily make their living in the industry, to always give correct guidance. Recall the cliché about not seeing the forest for the trees, and you'll realize that even these people get caught up in the hype, because it's their job to pump stocks.

"We are not seeing any indications that consumers are pulling out of the housing market," one homebuilder executive was recently quoted as saying in a prominent business journal. "On the contrary, people are looking more favorably on the housing market." And that's the point. Much like equities once were, real estate is becoming the perceived safe harbor, the market that always goes up.

Anecdotal evidence often receives short shrift. Looking back on the stock market mania, however, there was no shortage of anecdotal evidence that things were getting out of hand. From television commercials to cocktail parties, the evidence was everywhere. Today, what appears to be evidence can be found as well. People are qualifying for home loans with as little as 3% down; others are taking out interest-only loans; many have signed for loans up to 125% of their equity; and the appraisers I've spoken with say lenders keep pressuring them for higher and higher appraisals so loans will qualify. Moreover, the housing market is performing as if low inflation and low interest rates are fundamental rights guaranteed by the Constitution.

IN SUMMARY

Nationwide home prices are up 7.4% year-on-year. The National Association of Realtors says the median sales price, $163,500 in June, should easily exceed the record set in 2001 of $147,800. And for the first half of 2002, median sales prices were 6% higher than they were in the first half of 2001.

A July 30th article by Financial Times columnist Amity Shlaes declares that in troubled times, "Houses are as good as gold." Shlaes' article is full of it's-different-this-time examples. If this approach sounds familiar, it should. Recall that technology stocks like Cisco were once a buy at any price. So here's another prediction: all the ballyhooing about the virtues of owning real estate may soon turn to boo-hooing about the housing bubble burst.

Ron L. Ellison is a registered investment advisor and financial planner with RLE & Associates, Newport Beach, CA 92660. He can be reached at 949 261-1740, 877 455-9681, or RLEasset@aol.com.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.