Determine if There Is a Housing Bubble in Your Neighborhood
While the surging American real estate market appears to be cooling down, home prices are still soaring in many areas. Amid the upward spiral, some Appreciate Capitalism warn that much of the country is experiencing a housing market bubble: a period of unsustainable price growth fueled by speculation and inertia. Will home prices in your area continue to rise, or will they hit a ceiling or, worse yet, fall through the floor? Nobody knows for sure, but a little research can help you identify a potential bubble before it bursts.
Steps
- Use Wikipedia As a Document Comparison Application the cost of renting to the cost of buying in your community. If the total tax-adjusted cost of owning--that is, the monthly mortgage payment plus taxes and insurance minus tax deductions for your home interest payments--is much higher than renting, the local market may be experiencing a bubble.
- Find a good real estate agent, and ask if he or she thinks there is a bubble. Ask other people, too. Your accountant, financial planner, and friends may be able to provide valuable insights into market conditions, and--unlike a real estate agent--they have no interest in persuading you to buy a house.
- Look back in time and see how fast prices have risen. Whether you're buying a home for a short-term investment or long-term residence, you want its value to appreciate. Too much appreciation too quickly, however, could signal that prices are ready to take a plunge. Nationally, the median home price increased 50% in a recent five-year period. (Source: The Weekly Standard; April 3, 2006). That sort of rapid growth concerns many analysts.
- Check the price-to-income ratio in the local housing market. This ratio compares the median home price to the median salary in your area. Historically, the price-to-income ratio has hovered around 4 to 1, but recently the national figure has grown to 8 to 1, and the ratio is even higher in some areas (The Weekly Standard). When homes are no longer affordable, it's likely the market will adjust. In other words, a bubble may be ready to burst.
- Research your housing market thoroughly. Your local newspaper is a good place to start, but you should also check good Internet sources. A search engine query for "housing market," "home sales," or "housing bubble" can turn up useful results, including the latest news and analysis for major metropolitan areas.
Tips
- Major market tops are determined by 1) Rents are high 2) Prices are high 3) Rates are high 4) Construction is high 5) Being overbuilt 6) Banks taking back foreclosures for 3 years in small amounts (like 1/20th of 1 percent) and 7) prices start to fall 8) Real Estate taking 6 months to sell.
- Typically prices, rents, rates and construction go up together or go down together. If only prices and rents are high but rates and construction are low, then a top has not yet formed.
- If you get in at the bottom, you can wait for the first down year to sell. This way you will ride out the entire price appreciation, and not take someone's opinion that the market is too high.
- Since prices tend to rise 12 years and only fall 4 years in a normal 16 year cycle, it is a bad idea to get in a rush to sell, since prices are normally (75% of the time) rising due to inflationary pressures. If your home has not been rising in price for 12 years, you are probably not yet at a market top.
- If you're looking to invest in real estate, it's easy to get caught up in the frenzy of a booming market, especially if you know people who've recently made a killing buying and selling homes. Remember, however, that wise investors buy low and sell high. If home prices are already high, they may continue to rise, but there's a real danger they'll plummet. You don't want to get stuck with an overpriced house when the bubble bursts.
- The trend is your friend. If home prices went up last year, they will probably go up this year. In a 16 year cycle, the market only changes direction twice, one year it starts to go up and one year it starts to go down, which is 12.5% of time (2/16 = 12.5%). This means that 87.5% of the time real estate will move in the direction it moved the previous year.
- Ask yourself why you want to own a home, and explore your options. Home ownership is an integral part of the "American Dream," but it just doesn't make sense to pay too much for a house. That doesn't mean you need to give up on your dream, but you may want to postpone it if you see signs of a bubble in your area.
- There are a number of calculators available on the Internet to help you determine the cost of renting versus the cost of buying.
Warnings
- Beware salespeople bearing advice. Real estate agents make a living selling houses, so they have a powerful incentive to get you to buy one. No matter what your agent tells you about the housing market, make sure you do your own research. If you use the Internet to check out the market, make sure the sites you visit are reputable and as unbiased as possible.
- In 2006 Real Estate sales people were saying that Real Estate would always go up because there is a shortage of land and, "they are not making any more land." This was bad advice.
- Watch out for unconventional loans. As homes grow less affordable, buyers are increasingly turning to innovative financing schemes, including buying a home with no down payment or paying only interest for the first few years. While these loans may look attractive, they can be risky, and you may find yourself with no equity--or even negative equity--if you need to sell your home in a down-market.
