Why the Bubble Won’t Burst

David Schubb, October 13, 2005

 

 

There are many factors that will prevent a bust in the real estate market.  The basic concept of supply, demand, and purchasing power will continue to keep values rising, not plummeting.  The following data was obtained from the California Association of Realtors.

 

What is a bubble?

When stock market prices fell, many sold their stock.  The market was flooded with inventory and values fell.  Owners of real estate, in a declining market, will be less likely to dump their property, especially if it is their home.  Without the “dumping” of property, the supply will not rapidly increase - which helps keep prices high

 

Nasdaq 1987 – 2005

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 Why are home prices rising?

·        Strong Demand

o       Low Mortgage Rates (purchasing power)

o       Demographics: Baby Boomers (increased demand)

o       Flight from alternative investment choices (increased demand)

o       Speculation? (increased demand)

·        Restricted Supply

o       Constraints on new construction  (reduced supply)

o       Low inventory of homes for sale (reduced supply)

·        Low Interest Rates (purchasing power)

·        Consumer Confidence

o       Real estate is an emotional need, not a commodity.  Consumer confidence is the single largest factor in determining whether or not one should buy or sell their real estate (residence or investment).  Just because values may fall, homeowners will keep their residences because they live in their homes first and keep them as an investment second.

o       Consumer outlook improving as economic recovery and expansion become more evident.

§         10/93:    41.0

§         08/98:  126.9

§         03/03:    63.0

§         09/04:  107.3

§         Record sales in 2005 – 643,380 Initial forecast had been for  -2.5%

§         2005 sales up 3%

§         2004 sales up 3.8%

§         2003 annual sales up 5.1% from 2002

§         2002 annual sales up 13.6% from 2001 

§         2001 annual sales down 5.9% from 2000 YTD

§         2000 annual sales down 0.4  from 1999

§         1999 sales up 6.4% over 1998

 

The following chart demonstrates consumer confidence in the western United States:

Sales of Existing Detached Homes and Pacific West Consumer Confidence

California, July 2005 Sales: 647,913 Units, Up 3.3% Y-T-D, Up 1.3% Y-T-Y

 

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 One of the factors that would create a bubble to burst would be an increase in the supply of available property.  But, there remains a shortage of inventory:

·        Supply of homes remains at  low level but has turned up since March

·        Housing shortage moving to Southern California

·        Range since 1988:

o       Low: 1.6 months in March 2004

o       High: 17.7 months in Feb 1993

o       Long-run average 6.5 since 1988

 

The following chart reflects the lack of supply:

Unsold Inventory Index

California - July 2005 : 3.2 months of supply

 

 

 

 

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 There is also an insufficient amount of new home construction.  New housing permits for single family homes are less than 200,000 while the demand continues to outstrip the supply.

 

 

New Housing Permits: CA

 

 

The population continues to grow in California.

The following chart indicates that growth has been about 600,000 new residents per year.
Sources of Population Growth

California  1981-2004

 

 

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How can buyers continue to pay these high prices?  Where do they get the money?

Many home buyers have owned homes previously and when they sell them they have record amounts of cash to offset the high prices that they pay for a new home.

 

Median Net Cash To Sellers

 

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 Prices increases are slowing:

·        Median home price continues to climb but at a slower pace

·        High: June 2005 $543,120

·        Largest year over year gain was May 2004 over May 2003

·        2000 annual median price up 10.9% over 1999

·        2001 annual median price up 8.7% from 2000

·        2002 annual median price up 20.5% from 2001

·        2003 annual median price up 17.9% from 2002

 

Median Price of Existing Detached Homes

•         California, July 2005: $540,900, Up 17.1% Y-T-Y

 

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 Why are we are seeing an adjustment in the market?  The supply has increased slightly, the demand is still strong, and interest rates have increased.  These factors would indicate that prices should go up at a slower rate or decline.  However, with the above indicators, it doesn’t seem likely that prices will decline.  Here’s CAR’s prediction:

 

·        Market in Transition

·        Bay Area and So Cal Coastal areas median price up 6-12%

·        Central Valley and Inland Empire growing most rapidly; median price up 10-18%

·        No Bubble – Soft landing

California Housing Market Forecast