Local housing bubbles could burst in next couple of years

But outlook for overall real estate market stands strong
By: Glenn Roberts Jr.: Inman News
WASHINGTON, D.C. – The housing market remains unusually strong, but speculators and lenient lending practices do pose a risk for the real estate industry, said David Lereah, chief economist for the National Association of Realtors.

Lereah, during a presentation Thursday at the National Association of Realtors' midyear meetings, said he expects that some hyper-extended local real estate markets will sour within the next couple of years, while the overall housing market should remain robust for at least the next couple of years.

"Loose lending and speculative buying – that, in my opinion, is the greatest risk that our industry faces right now," Lereah said.

Wall Street analysts are definitely paying attention to the migration of investors to the real estate sector, and that has put the industry under increasing scrutiny, he also said. "They are watching us. We are under a microscope."

Analysts have found some reason to be concerned – increasing debt, fast-rising home prices in some markets, a larger share of adjustable-rate mortgages, and a higher share of home-price-to-income and home-price-to-rent ratios in some markets. Financial scandals that have plagued mortgage giants Fannie Mae and Freddie Mac could lead to some industry-shaking reforms, the trade deficit is swelling, oil prices are gushing, and the value of the dollar is dropping.

Most local "balloons" in home prices "will deflate rather than pop," though "several local markets will pop over the next couple of years," he said.

Among the indicators of a market headed for a bust: home sales falling, price growth below historical average, more than a 6.5-month supply of housing, properties taking longer to sell, job loss in the area, rising mortgage rates, negative net migration, and rising loan-to-value ratios.

The days of successful speculative buying in some real estate markets are numbered, Lereah said, citing the example of pre-construction buyers in a hot real estate region.

"People will purchase pre-construction and they'll flip it and make some money. Can they sustain it? No. At some point that won't work." While there are speculators, their activity represents only a small part of overall home buying, he said.

There is definitely a flip side to the negative indicators, though, Lereah added. Inventory is still constrained in many markets, producing the simple economics of high demand. "How many times do we have to tell Wall Street that demand is higher than supply?"

The Baby Boomer generation continues to invest heavily in real estate, and housing is still largely affordable in most parts of the country. "The stars are aligned for the housing sector. I say this is the Golden Age of real estate," Lereah said.

For the past four years, Lereah has predicted a let-up in the galloping housing market, but he said it hasn't yet paused for breath.

Unless interest rates rise above 8.5 percent, affordability should not be a problem, he also said. Modest increases in interest rates and inflation should allow a soft landing rather than a freefall for the real estate industry, he added.

Housing markets in other nations exhibit more bubble-like symptoms than the U.S. market, Lereah noted, with the United Kingdom and Spain, for example, reporting some very high price-to-rent and price-to-income ratios.

Lereah expects 6.5 million existing-home sales in 2006, compared to a projected 6.71 million this year. New-home sales should also drop slightly, from a projected 1.18 million this year to 1.05 million next year.

Rates on the 30-year fixed mortgage, meanwhile, could increase from about 6.1 percent this year to 6.7 percent by year-end 2006. And existing-home prices should slow, from 7.1 percent appreciation this year to 4.5 percent appreciation in 2006.