September 11, 2004


Is the Housing Boom Over?: Home prices have gone up for so long that people think they'll never come down. But the fundamentals tell a different story—a scary one. (Shawn Tully, Fortune)

For years the debate has been raging: Is it a bubble or isn't it? Two years ago FORTUNE looked at the housing market and saw reasons to be concerned. While home prices nationally were only 5% to 10% overvalued, we said, some frothy markets, mainly on the coasts, were more than 20% above historical norms. Our conclusion: While the trends were worrisome, "for the nation as a whole, no housing bubble exists ... we're not there yet."

Two years later it looks like "there" is finally here. The housing market is rapidly losing touch with reality. Fueled by interest rates that have remained near record lows, prices have continued to soar, and the gap between home values and the underlying fundamentals such as personal income and job growth is greater than ever. The most alarming development, though, is the change in psychology. "The market isn't acting rationally," says Christopher Thornberg, an economist at UCLA. "It's now an emotion-driven market where people are buying on the expectation of future appreciation." Increasingly Americans view houses not primarily as places to live but as foolproof, can't-lose investments. The passionate faith that money poured into real estate will magically multiply is creating a self-fulfilling speculative frenzy that's bound to end badly.

We're agnostic on the notion of real estate as an investment, but the paragraph above leaves out the single most important reality if you're looking at the housing market--while in the last twenty years of the 20th century the U.S. grew by over 50 million people, roughly the population of France, the U.S. population is on pace to grow to 400 million by 2050, an addition of over 100 million people, more people than live in the Philippines. People need places to live and if there aren't enough places then the ones there are will cost more.

Posted by Orrin Judd at September 11, 2004 8:50 PM

Of course you can add to this mixture the insanity being practiced in all parts of CA today.
The last guy to close escrow, in conivance with local politicians and the anti-human enviro groups, has successfuly removed millions of acres, much of it at taxpayers' expense, from potential homebuilding.
The developers who create the housing for the ever present buyers are demonised and compared to the spawn of Satan.
Politicos at the State and Local levels then tell the taxpayers et al that affordable housing must be provided and the only ways are to spend more taxpayer money to build houses that already spent taxpayer money kept from being built.
None of this could have happened if the Warren Court had not created some "one man, one vote" decision which effectively changed CA's legislature in the 60's from the Federal model, Assembly by population and Senate by county, to everything by population. Guess what happened?
The CA Legislature is the best argument existent on why the Electoral College is necessary.

Posted by: Mike Daley at September 11, 2004 9:08 PM

That's not what is driving the market to unsustainable levels. It has been dropping interest rates over the last 4 years which has made the increase of housing prices affordable based on the lower interest components of the amortized mortgage payment. Even if rates do not rise, they will not fall from here, so further appreciation cannot come from this source. When this realization takes hold, speculative buying pressure will evaporate. If rates rise from here, then current prices will become unaffordable.

Prices won't rise just because of new demand, they will only increase based on increases in income levels.

Posted by: Robert Duquette at September 11, 2004 10:42 PM

The price is housing is not determined by the sales price, it is instead determined by the amount of monthly payment a buyer feels he can carry, usu. around 28% of AGI. Interest rates are at an all-time low, so that any change in the near future is likely to be in the upward direction. Also, a significant percentage of the market is using adjustable rate mortgages, in an action of supreme folly.

Posted by: Bart at September 11, 2004 10:42 PM


Rates fell because of deflation--you can't reverse that.

Posted by: oj at September 12, 2004 12:28 AM

"The CA Legislature is the best argument existent on why the Electoral College is necessary."

No, Al Gore is.

Posted by: some random person at September 12, 2004 12:45 AM

I have no doubt whatsoever that, in real terms, homes being purchased now will be more valuable in '50.

However, most people don't want to wait 45 years to turn a profit on their homes.
For the reasons that Fortune magazine, Bart, and Robert Duquette have outlined, the next few years may be rough for homeowners in the thirty markets that Fortune listed.

Besides a rising population, another factor that will put upward pressure on housing costs is the trend towards longevity, which will result in a lower desired population density per household, and retard turnover of housing stock.

On the plus side, we should be able to get some really good deals on vacation homes in Europe in a few decades.

Posted by: Michael Herdegen at September 12, 2004 3:10 AM

Guys, guys, guys. Let's put down the intelligencia hat and look at things the way real people do.

You've got to live someplace. You either live in a rental apartment and pay rent or live in your own home and pay the mortgage. Even with ZERO appreciation, if you own a home, the 361st month your payment drops to zero. If you rent, the 361'st payment is the same as the 360'th. As is #362, 363 and all the rest.

The housing market will continue to grow as long as people keep having babies.

Posted by: ray at September 12, 2004 3:22 PM

Ray, the housing market can expand without contributing to the appreciation of housing values. There is plenty of land to build on. The only thing that will drive home prices up in the long run is inflation and/or income growth.

Posted by: Robert Duquette at September 12, 2004 11:01 PM


You miss the point. It's not important that they appreciate much, only that you're saving rather than spending.

Posted by: oj at September 12, 2004 11:09 PM

One way that "real people" look at things is, when home prices appreciate by 100%, they start throwing up homes as fast as nail guns can fire.

That certainly depresses future appreciation.

There are a few places where that cannot happen, such as the People's Republic of Boulder or many parts of northern Cali, but by and large, it's being done.

There are many lifestyle advantages to living in one's own home, but in many places, mortgage payments are higher than rent. There may be only 360 payments to make, but there're also higher insurance costs, as well as maintenance costs.
Even factoring in tax breaks for homeowners, it's not always true that purchasing a home is a long term financial plus.

Posted by: Michael Herdegen at September 14, 2004 2:29 AM