Sunday, October 01, 2006

Housing Bubble Myth – Don’t Panic!

The pendulum of fashionable conversation has swung. Cocktail conversation now favors talk of bubble bursting and the fate of your newly moved in neighbors. I find all this bubble talk quite amusing. Apparently, I bought into two previous Washington DC metro area bubbles, 1981 and 1989. I did just fine, thank you very much.

From exactly what point in American housing history do we measure the great Housing Bubble? If a man purchased a house in Fells Point, Baltimore in 1966 he might have paid $8,000. Did he pay too much? With or without proper maintenance, despite surging inflation, that same house might have sold for a mere $4,000 by 1976 during the era of Baltimore’s give away Dollar Houses. Ouch, he had a 50% loss! He must have paid too much! Was it a time to panic? Surely only a fool would pay $4,000 in a descending market to buy a house in Fells Point at that point in time. Would that serve as proof in 1976 of a previous 1966 Fells Point peak housing bubble? That poor foolish owner had lost 50% of his equity in just 10 years, but only if he sold in 1976. Of course, if he didn’t actually sell, it was just grim cocktail conversation, a paper loss.

By 1989, that same house, with or without proper maintenance would sell for $160,000. Wow, a gain of 2,000% (or perhaps 4,000%) in just 13 years! Was the owner a genius to have bought or held back in 1976? Surely that would now represent a peak Baltimore real estate bubble in need of an explosive bursting.

But wait, fast forward to 2005, that same house sold for $485,000. Another 300% gain. The total 40 year gain on that same Fells Point house purchased in 1966 for $8,000 is over 6,000%.

I guess that this time it must really, absolutely, positively be the real estate bubble that must be popped. Nobody will ever again pay that kind of money for a house in Fells Point, or will they…

Trying to spot a bubble from within a market is next to impossible. Over any given period, prices can go up and down more than once, but the general direction in many desirable markets has been inexorably upward. Perhaps the criteria for spotting a bubble is whether or not a place is a desirable place to live over the long run.

If we see prices fall 30% over the next 5 years does that spell the end of long-term property values in desirable locations? No! You must keep your eye on the distant horizon. A house bought in 2005 for $500,000 may well fall to $350,000 in 2010, but so what? Stock also rise and fall, but you can live in and enjoy your house, not so your stocks. If 50 years of past history are any guide, that same house will likely turn upwards and hit $1,500,000 by 2020.

If you believe that America will be a long term successful international player, then property prices in America must continue to climb, and probably climb to ever lofty more unimaginable heights over the long run. To believe otherwise would be to place a bet against America.