Bubble Trouble? Protecting Your Investment in Today's Hot Housing Market
Written by: Lankarge/Nahorney for HomeInsight
Protecting Your Remodeling Investment in Today's Hot Housing Market
First the good news: Housing equity - the value of our homes minus any mortgage debt — increased from $7.1 trillion to $10.6 trillion in the past five years, according to the National Association of Home Builders. Rocketing house appreciation, low interest rates, and stronger job growth have all fueled unprecedented levels of home ownership and spending to remodel these homes. According to the U.S. Census Bureau, Americans spent $200 billion in 2004 on home improvements, a 12 percent increase over 2003, and the largest jump in such spending in more than a decade.
Now for the sobering news: Between 2000 and 2003, the number of American households spending more than 50 percent of their income on housing grew by 2.5 million, according to Harvard University's Joint Center for Housing Studies. In fact, today 1 in 8 of us spends more than half of our income just putting a roof over our heads.
Even more troubling are recent remarks made by former Federal Reserve Chairman Alan Greenspan, cautioning us that the current hot housing market won't last. "The housing boom will inevitably simmer down," he said at an August Fed conference in Jackson Hole, Wyoming. "As part of that process, house turnover will decline from historic levels, while home price increases will slow and prices could even decrease."
Decrease? This idea may come as a bit of a shock to those of us who have gotten used to low interest rates and double-digit increases in housing prices. Our exuberance is fueling record high borrowing against the equity in our homes - equity which many of us have tapped to finance big tickets items or home improvements in hopes of further increasing the value of our nests. Yet many economists are now warning we shouldn't get too comfortable with the notion of continually soaring real estate prices. "Such an increase in market value is too often viewed by market participants as structural and permanent," said Greenspan. "History has not dealt kindly with the aftermath of protracted periods of low-risk premiums."
History shows us that bubbles - which occur when investors put so much demand on a commodity that they drive up prices beyond any rational reflection of its actual worth - do indeed deflate. Remember the dot.com crash? From March 11, 2000 to October 9, 2002, the Nasdaq composite lost 78 percent of its value as the market began a protracted two-year freefall from 5046.86 to 1114.11.
Bubbles and busts are by no means a modern phenomenon. During the peak of "Tulip Mania" that gripped the Dutch during the 17th century, one tulip bulb fetched upwards of $35,000. Speculators, supremely confident that the popular flower of the rich and famous was a "sure thing," mortgaged their homes and businesses and sold all their possessions just to buy a single bulb. Then the "unthinkable" happened: someone actually floated the notion that tulips were wildly overvalued and began selling their stockpiles. Without warning, investors began dumping their bulbs. In less than a week, a bulb that cost $50,000 to buy was worth less than a dollar. Many folks lost everything.
Although houses are certainly not tulips, some economists see parallels between Tulip Mania in the 1600s and "Housing Mania" in the millennium, especially in hot housing markets. According to Harvard University's Joint Center for Housing Studies, the number of metropolitan areas where the median house price-to-income ratio has risen to at least 4 (the normal average is 2.7) has more than tripled from 10 to 33 in the past five years. These high-priced markets include southern California, New York City, Boston, and the larger metro areas of southern Florida where home prices have increased nearly 30 percent to 50 percent in just a few years.
Conventional wisdom tells us these prices are not sustainable in the long term, but it still remains to be seen whether the current hot housing market will slowly run out of steam and prices will naturally correct themselves, or whether the whole ceiling will suddenly come crashing down with a resounding THUD. But if you're afraid the market is starting to go south, you can help protect your home value and plan for the future. By arming yourself with solid local market information, you can make wiser decisions about what home improvements you should make or whether you should skip the remodeling altogether and move.
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