Market Watch: Bubble-Free Zone

Fear that rising home prices will fuel market instability is unfounded.



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Even though home prices in the valley have risen 55 percent and distressed sales have fallen to 15 percent from a high of 60 percent, many people worry about this housing market — not just in the desert but also throughout the country. Some believe prices might be forming another housing bubble. Others worry that early foreclosure investors will begin selling their investments, raising inventories and depressing prices. In our opinion, only one of these issues has merit — and just slightly.

Fear of Bubbles

I’ve studied market bubbles for more than 40 years. In fact, I wrote a book in 2000 on the stock market dot-com bubble, and the current housing market shows no signs of impending trouble. One important sign there is “no bubble” is the constant talk and worry about one. While this may seem strange, it’s rooted in history.

Bubbles occur after many years of constantly rising prices. Buyers become convinced the market carries little risk, since prices never seem to decline. Any warnings that prices have advanced beyond what the economy or wages can support are thought “out of touch” and generally ignored. That prices continue to move higher is proof these warnings are wrong. Alan Greenspan called this condition “irrational exuberance,” and it doesn’t exist today.

“Normal” Affordability

What we have now is simply a rapidly recovering housing market driven upward by a special Federal Reserve program that keeps mortgage rates low. When we measure home prices against affordability — the percentage of homeowners who can afford the current median-priced home — we find no bubble; prices are generally in line with historic norms.

Foreclosure Investors

We do think there is validity to the worry that investors might begin selling, but we believe it is somewhat overblown.

During the dark days of valley housing — from 2010 through 2011 — we had an inverted market that couldn’t right itself. The normal mechanisms to rebalance weren’t there. Too many buyers throughout California were underwater, and those who could buy were restricted by extremely tight lending conditions. Then an army of cash investors came forth who bought up the huge inventory of distressed homes. Resented by some for their good timing, they did help turn things around and save the day.

Even with the recent, large price increases, many of these investments still produce rental returns more than 6 percent. If investors sell, they must face the question “Where will I put my money?” With investment rates still at record lows, there is no good answer. So we believe they will sell only if they think prices might decline. So far, conditions don’t point to this possibility.

Riverside Median Price and California Affordability Watch Ranking chart

Vic Cooper and Mike McDonald are partners in Market Watch LLC, a nationally recognized real estate advisory firm that publishes The Desert Housing Report. Visit www.marketwatchllc.com.


 

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