My old roommate, the Hammer, is an options trader. For a couple of years, he had targeted this spring as his time to finally stop renting and buy a one-bedroom apartment; another round of bonuses and he thought he could finally afford a down payment. A couple of weeks ago, he called me to say that he had changed his mind. “I just can’t do it,” he said. “Remember the way everyone used to talk about internet stocks five years ago? ‘I just bought Cisco Systems and Sun Microsystems. Of course they’re going to go up – they always do! Nah, I don’t know what they do . . . but who cares?’ Well, it’s the same way with housing these days. All anyone can talk about at the water cooler is how they need to get into the market so they can flip properties. Heck, Johnny Baseball” – a mutual friend of ours – “just flipped his one bedroom for a 50% ROI in a year. He’s a smart guy, sure, but that was the first real estate transaction of his life!”
Unfortunately, not everyone agrees with the Hammer. According to some commentators, now is as good a time as any to invest heavily in housing markets. Last week, Neil Barsky asked “what housing bubble?” in that Bible of Capitalism, the Wall Street Journal:
The reality is this: There is no housing bubble in this country. Our strong housing market is a function of myriad factors with real economic underpinnings: low interest rates, local job growth, the emotional attachment one has for one's home, one's view of one's future earning-power, and parental contributions, all have done their part to contribute to rising home prices.
We’ve focused quite a bit on the evidence of a housing bubble here at Warren Reports, so I’m not going to go into detail dissecting Mr. Barsky’s analysis. (For information as it develops, check
The Housing Bubble Blog.) But suffice it to say that his view is both extremely contrarian and the type of thinking that is dangerous to middle class families.
Does everyone remember the book
Dow 40,000? How about
Dow 36,000? Of course, the personal investors who tried to catch the technology-induced stock market wave too late ended up wiping out. Bromides for “damn the torpedoes, full speed ahead, it’s a whole new paradigm investing” have a funny way of appearing around the same time as market peaks.
Unfortunately, it's typically middle class investors who are the last ones in and the ones hurt the most when markets turn. Mr. Barsky makes sure to tell us that he owns stock in several homebuilders and it’s nice to know that he puts his money where his mouth is. But we don’t know what share of his portfolio those homebuilders are and we don’t know what his basis is for those trades.
Insinuating that housing markets aren’t over-priced without warning potential homebuyers of the potential risks they face is a little misleading. Housing purchases are very levered and, due to external circumstances like changing jobs and familial situations, homebuyers often don’t have the luxury of carrying their homes through market corrections. And my guess is that the typical middle class homebuyer is going to be much more highly concentrated in the housing sector than Mr. Barsky will, making the potential damage done by fluctuations that much greater.
Of course, Mr. Barsky is entitled to his opinion – it’s often nice to hear a different view. He is right that a housing correction will be different from a stock market correction because of the utility of the asset. But not everyone who purchases a house, just as not everyone who purchased an internet stock, is a sophisticated investor. I only hope that most Wall Street Journal readers and, more importantly, most middle class homebuyers presented with information about the never-ending rise in housing prices remember the technology collapse of just five short years ago. I think The Hammer is right to wait.
If you drive through the suburbs of NJ, for example, there are 700K+ houses up everywhere. I can't imagine that there are that many high-paying jobs out there that allow all these people to afford that lifestyle.
I think if and when a correction takes place, a lot of these people are going to be in trouble.
I rent -- can you tell? :-)
There was a NYT article about a month or so ago that confirms what your trader friend says -- people are treating the real estate market like stocks in the late 90's. They made an interesting comparison between P/E ratios and something about the house/apt. price versus the rent you're able to collect on it??? Something like that...did some searching, but can't find the article.
August 3, 2005 4:59 PM | Reply | Permalink
Financial bubbles are similar to pendulums in that one can be confident that they will swing back to the middle and probably beyond. The crucial difference is that they don't move smoothly and predictably. Even when the pendulum is way the heck out there, it may have another fortune-making lurch or two in it before swinging back. You play that game or you sit it out. One of Paul Krugman's all-time great columns from 1998 captures it as well as anything: http://www.pkarchive.org/theory/iceage.html.
August 4, 2005 9:13 PM | Reply | Permalink