Archive for Sunday, September 4, 2005

Detecting a housing bubble isn’t easy

September 4, 2005

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The experts can't decide whether there's a housing bubble or not.

That's no surprise. If bubbles were easy to spot, everyone would flee the market at the first warning sign and bubbles would never develop.

Just think of the Internet bubble of a few years ago. Some people thought it was a bubble well before the crash proved them right. But others thought the rules were different in the "new economy" and that it made sense for the stock of a money-losing company to skyrocket.

You don't get consensus on a bubble until it bursts and prices collapse.

How can a home shopper spot the overheated communities where home purchases are too risky? There's no foolproof way, but answers to some questions may raise red flags.

For example: How much have prices gone up? This is common sense. A bubble is more likely in a community where prices have soared than on one where they have not.

Is there a clear reason for prices to jump? If a big company has just put up a headquarters nearby and moved in a lot of well-paid personnel, you can expect high demand to push home prices up - and to keep them there. So maybe it's not a bubble.

What's going on in nearby communities? They could be in bubbles, too. But the broader your research, the better the chance you'll sense when rising prices fell wrong. Try to compare apples to apples, looking at communities with school systems of similar quality, residents with similar incomes and so forth.

Are new owners living in the properties they buy? If they're not, these are investment properties and there's a better chance the buyers have stars in their eyes and are paying more than they should. This happens often, for example, in vacation areas, where owners plan to rent properties out or to sell them quickly.

How long are homes on the market before selling? If they're being scarfed up in a week or two, the buyers may be over-eager, and paying too much. When markets are really over-heated, buyers get into bidding wars and end up paying more than the sellers had initially asked.

Are there reasons an economic downturn might be especially damaging? An area that depends on one big employer or industry is riskier than one that's more broadly based.

Is there a limit to the housing supply? If there is lots of undeveloped land nearby, builders may rush in to capitalize on high prices. As the supply of homes rises, it will be harder for sellers to compete, and prices may level off or fall.

How long do owners keep their properties? If homes that sold last year are on the market again, owners are trying to make quick profits in a speculative market. Beware.

Finally, what are your own intentions? Even if you buy during a bubble and prices then fall, you'll probably be OK if you stay in the property for many years. Over time, you can expect housing prices to rise at the inflation rate, which averages around 3 percent. So even if you take a 20 percent loss soon after buying, you could be back in the black in seven or eight years.

Real estate brokers should be able to help with these questions. But be sure to pin them down, asking for the source of any figures - and then verify them. Don't settle for generalizations such as, "Oh, this is a great neighborhood - prices always go up."

As a buyer, you have a right to deal with as many brokers as you want, and it's a good idea to get views from several. Brokers work for sellers, and make bigger commissions when prices are higher. So you can't count on the broker to warn you off when the market is overheated.

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