Washington is caught up in a housing bubble affecting a couple of dozen urban areas nationwide, characterized by soaring home prices and increasing speculative activity in local real estate.
As people learned with the stock market bubble in 2000, the ride up may be exhilarating for investors and homeowners, providing an opportunity to make big money, but the ride down —if the bubble bursts — can be devastating to people’s finances and crippling to the economy.
Washington area home prices surged 24 percent last year, twice the national rate and the fourth straight year of double-digit gains, according to the Office of Federal Housing Enterprise Oversight. Since the late 1990s, home prices have doubled in northern Virginia and many other parts of the region.
Richard DeKaser, chief economist with National City Corp., estimates that Washington is one of 28 U.S. cities where houses are 10 percent or more overvalued, based on income levels and other factors, and could be in a bubble.
“There is a growing risk of ‘bubblettes’ in certain places,” although the U.S. market overall does not appear overpriced, he said.
Standard and Poor’s Corp. has placed Washington among a group of major U.S. cities where it expects home prices to retreat because of unsustainably large gains characteristic of a bubble in recent years.
So far, the huge gains in prices and booming home sales have mostly benefited the 69 percent of Americans who own homes. They have been able to sell at a profit, or cash into their rising home values through cash-out refinancings and home-equity loans to pay for renovations, college educations, new cars and a myriad of other things.
The increased household wealth caused by soaring home values also has given many baby boomers sizable real estate assets that they hope to cash into when they retire. As a result, many have let their retirement savings slip.
The main downside has been sharply increasing property-tax assessments driven by skyrocketing valuations — forcing homeowners to pay hundreds of dollars more each year. Many area residents got big, new assessments just this month.
Also, young, first-time home buyers and working-class families are finding it increasingly hard to afford homes in Washington, where the median home value last year soared to over $350,000 — more than three times the average household income here.
A study by the Urban Institute and Fannie Mae Foundation found that a family supported by a firefighter’s salary last year could afford to buy a median-priced home in only 12 Washington neighborhoods — all east of the city — down from 18 in 1998.
But even for homeowners basking in the benefits of booming prices, worries have risen about whether the market gains could evaporate as quickly as they came. That happened in the 1990s, though at other times, swift run-ups in prices have been sustained.
Easy come, easy go
Such suspicions are justified, say a growing number of economists and Federal Reserve members. They say a bubble most likely is developing in major urban areas on the East and West coasts, including New York, Boston, Los Angeles, San Francisco, San Diego and Washington.
Other areas that are overheated and could experience price setbacks, they say, are popular vacation and retirement spots such as Honolulu, Las Vegas and Palm Beach, Fla.
The home-investment craze, while primarily fueling a boom in major cities where wealthy and affluent people live and work, also has spawned a buying binge on second homes and investment properties in such resort areas.
Agents from resort cities on the Gulf Coast such as Sarasota, Fla., and Gulf Shores, Ala., report that the market is so heady that even the devastating hurricanes that passed through last year and leveled homes and infrastructure had little effect on beachfront property values.
The housing-investment boom started shortly after the stock boom ended in early 2000, as investors burned by stocks took solace in solidly rising home values.
The shift proved profitable. A housing-investment index published by the National Association of Real Estate Investment Trusts has outperformed stocks for five straight years, and hit a high of 30 percent last year.
A favorite form of real estate speculation in Washington and other areas is signing a contract on new homes or condominiums under construction, and then cashing in quickly as prices soar above the builder’s asking price.
In many cases, investors never set foot on the property, with some unloading their investments as soon as the homes are ready for occupancy. Others buy with an eye toward holding the property and using it for vacation, retirement or rental income.
Just in the last month, developers announced “buy now, pay later” pre-construction sales on major new housing developments in Miami, Las Vegas, Sarasota, Fla., Myrtle Beach, S.C., and Tucson, Ariz., among other areas.
The promise of quick riches is drawing investors both big and small, foreign and domestic. Real estate agents are very active in Washington and other hot markets both in promoting investments and snapping up properties themselves that they believe they can turn over quickly at a higher price.
In a typical investment scheme known as “flipping,” a distressed or otherwise undervalued property is quickly repackaged, sometimes with minimal renovations, and resold.
Ruth Williamson, a first-time home buyer in Washington, said a real estate agent tried to sell her and her husband a “flipped” property for $40,000 more than the home’s market value. Knowing it was a financial stretch, the agent offered them a “rent-to-own” deal that would have cost tens of thousands more. Sensing a scam, they declined the offer and bought the next available property at a lower price.
Among the experts who are worried about increasing “speculative activity” is Federal Reserve Chairman Alan Greenspan. The Fed’s concern, which appears to be growing day by day, indicates that the central bank is keeping an eye on the housing market as it increases short-term interest rates steadily.
Today’s historically low mortgage rates have been a key ingredient nurturing the housing bubble, economists say. For the last two years, the rate on 30-year mortgages has averaged below 6 percent — the lowest in a generation — despite the Fed’s efforts.
Analysts believe that is because foreign investors have joined in the housing and home-finance frenzy and are subsidizing U.S. rates by snapping up U.S. bonds and mortgage-backed securities.
Still, Fed governors and most economists agree that while bubbles may be developing in certain coastal areas, a nationwide problem has not emerged.
A local problem
National statistics show that housing prices, while growing smartly in recent years, have not outpaced inflation or income growth in any alarming way. Because of this, most economists and industry experts expect prices overall to level out rather than decline when the boom is over.
“There is no countrywide bubble in house prices, but there are bubbles in house prices in as many as 27 U.S. cities,” said Michael Youngblood, an analyst with Friedman, Billings, Ramsey & Co., with the most vulnerable areas those where house prices have far outstripped income growth in recent years. Included on his list are Boston and New York. Most of the areas identified as the most overvalued by both Mr. Youngblood and Mr. DeKaser are on the coast of California.
Washington is not included on Mr. Youngblood’s list because income and job growth, thanks to defense and homeland security spending, has been particularly strong here in the last four years and has to some extent justified the explosion in house prices, he said.
“It’s certainly possible Washington will get into the bubble category,” he said, suggesting neighborhoods here that have “cracked seven-digit” house prices are the most suspect at present.
Washington has areas in the eastern part of the city and suburbs that are still reasonably priced and affordable, he said, creating an escape valve from high prices not available in other bubble-prone regions.
In addition, while household incomes in Washington are among the highest in the nation, the region does not have as many extremely wealthy households as New York or Los Angeles.
“People with exceptionally high incomes have the effect of skewing house prices higher because they can chase house prices” and invest in many properties, he said.
In addition to high incomes, another characteristic of areas with overheated housing markets is they have a lot of zoning and environmental restrictions, making the availability of land for housing development scarce.
Such restrictions, which are common in Montgomery County and other areas of Washington, drive up the price of housing. Cities with fewer restrictions, like Atlanta, have had no problem with house prices soaring beyond reach, Mr. Youngblood said.
Investors’ top pick
While home prices in Washington have not yet skyrocketed to Manhattan levels, speculative activity is on the rise in both residential and commercial real estate. For the third consecutive year, the Association of Foreign Investors in Real Estate recently named Washington, D.C., as the world’s top urban real estate market, citing low vacancy rates and the promise of spectacular price gains.
The rapid appreciation of home prices in Washington is what landed it on Standard & Poor’s list of overheated housing markets prone to declines.
Joseph P. Quinlan, chief market strategist with Banc of America Capital Management, cites a litany of statistics he says suggest “a great deal of froth” in the housing market. They include record new and existing home sales for several consecutive years, record levels of homeownership, and the steepest 10-year climb in housing prices in 50 years.
Roger Kubarych, economist with HVB Group, said he fears the Fed and financial markets are ignoring the warning signs of a bubble.
“Nothing comes closer to signifying the re-emergence of an inflationary psychology in the United States than the run-up in housing prices, fueled by abundant, cheap mortgage financing and home buyers who are shunning other assets, especially equities and equity mutual funds, because of perceived risks,” he said.
“Presumably, they see little risk in the housing market and are rushing out to buy new and existing homes before prices go up further.”
One reason even experts may be underestimating the problem, he said, is that current measures of inflation have grossly understated spiraling housing costs.
The Consumer Price Index, for example, does not directly incorporate rapidly rising home prices, but rather relies on an abstract measure called “owners’ equivalent rent,” which is derived from the more subdued rate of rent increases in recent years.
During the last year, the index’s housing-cost measure as a result rose 2.3 percent while home prices on average soared by 13 percent — a “huge disparity” that obscures the problem, Mr. Kubarych said.
Despite mounting evidence, some economists and many real estate professionals are not convinced there is a problem.
Tom Kunz, president of Century 21, said he doesn’t think the market is seriously overstretched.
Baby boomers are at the height of their earning and buying power and are starting to inherit trillions of dollars of wealth from their parents, he said. They have decided the best investments are their homes and second homes.
“Anywhere there’s sun or oceans, there’s demand,” he said.
The American dream
Meanwhile, immigrants are the fastest-growing part of the population and will remain a mainstay of the housing market through thick times and thin, Mr. Kunz said.
Prices may look toppy in a few places like San Diego and Orange County, Calif., but “there are still some great buys around the country,” he said, suggesting that Phoenix and Reno, Nev., for example, still have room to grow.
Even if prices flop in some overheated markets on the East and West coasts, they’re likely to bounce back again like they did after the last real estate bust in 1990, he said.
The craze for real estate is a worldwide phenomenon right now, he said, but the prospects in many ways remain best in the United States. “We have a thriving economy. Interest rates are at great levels” he said.
John P. Calverley, chief economist at American Express Bank, said much worse bubbles have developed in Australia and the United Kingdom, which lately has seen a decline in prices.
“The U.S. seems to be in the early-to-middle stages of a housing bubble,” he said, noting such telltale signs as a relaxed monetary policy, falling savings rates and a flood of new investors — as was seen during the stock bubble.
He cautions investors and homeowners against trying to time the market, and said they should protect themselves by ensuring their assets are diversified.
Economists warn that the consequences could be broadly damaging for the U.S. economy if there is a significant pullback in home prices.
Consumers have doubled their mortgage debt from $3.5 trillion to $7 trillion since 1996, borrowing and spending profusely on the assumption home prices will keep rising. If prices retrench, that not only would hurt home buyers and lenders, but it could have a stifling effect on consumer spending, which supports two-thirds of economic activity.