The air is full of talk by economists, pundits and in some cases Realtors concerned about a potential reversal in the real estate boom. What follows is excerpts from an address given by David A. Lereah, PhD Chief Economist of the National Association of REALTORS (NAR) and author of Are You Missing the Real Estate Boom? (Published by Doubleday), on June 7, 2005 to the REALSOURCE Association of Realtors in Waldwick, New Jersey.
Dr. Lereah serves as NAR’s spokesman on economic forecasts, interest rates, home sales, mortgage rates, as well as other economic and policy issues and trends affecting the housing markets and real estate industry in the U.S. and abroad.
How does it feel being in the most talked-about industry (real estate) in the country right now? Everywhere you go, every newspaper you read, every television program right now – is it bust or is it boom? That seems to be the major question of the day. It seems to me that there are many people out there that would love to see a self-fulfilling prophecy that we’re going to bust. I mean, you read The Wall Street Journal every other day and they’re talking about the housing markets crashing. On CNBC you can see me debating somebody (who is) saying that the housing markets are going to crash. It seems that there are people that always see the downside to just about anything.
I will attempt to build a case – which I think is a very compelling case – of why this real estate expansion that we find ourselves in will continue. And it will continue for the remainder of this decade, most probably. You may see some balloons out there but the air will come out of the balloons rather than the balloons popping. That has been my message for the last four years. If people who live on Main Street listened to the people who work on Wall Street, we would have lost a lot of opportunities for making money, because over the last four years the real estate markets have gained over three trillion dollars in wealth and that now goes to the average household at $45,000 per household. That’s how America builds wealth today. We’ve never built wealth in the stock market. Never! The top ten percent of America builds wealth in the stock market. But for middle America, low-income America, the only opportunity they have to build wealth is through real estate. And that’s what you do; you give the opportunity for all Americans to build wealth.
Let me try to paint some pictures for you. First, this real estate boom. We call it a boom but it’s really just a prolonged real estate expansion that started at the end of 1991. Remember those days? We had double-digit mortgage rates in 1991. All throughout the 1980s we had double-digit mortgage rates. Do you know there are realtors today, who are so young, they’ve never, never experienced a double-digit mortgage rate; who’ve lived in a time period where they think of mortgage rates going down, rather than up, because that’s what’s basically been happening over the last 14 years. But we did have a time when we had double-digit rates. It could come back. That’s one of the risks that we all face. But let’s go back to 1991.
At the end of 1991, mortgage rates dipped below ten percent for the first time in over a decade, and something happened. We had a refinancing boom. All of a sudden, the country started refinancing their mortgages. Then in 1993, mortgage rates came sliding down even further and we had the second refinancing boom that started this ball rolling uphill for the next 14 years. When you look at 1991, the country did 400 billion dollars in mortgage originations. Last year we did almost four trillion dollars of mortgage originations. The mortgage business increased tenfold in just a little over a decade’s time. Home sales back in 1991 were three million – new and existing. Last year we did almost eight million home sales. We more than doubled the size of the industry, in just over a decade’s time. That is a real estate boom. Imagine any other sector of the economy more than doubling in size in over a decade. Imagine the automobile sector, which has 16 million automobiles every year, producing 32 million automobiles every year. Imagine what would happen in that sector. The real estate sector, the biggest sector of the U.S. economy, doubled in size, and when you look at what happened over the past 14 years, you realize this is not just low mortgage rates. There must be something else that happened to give us what we have today. Something happened in our industry and it starts with 1991. It starts with the refinancing boom. All of a sudden, because people refinanced, they felt more comfortable with financing property. How many people here today have refinanced a mortgage, over the last ten years? Everybody! Not just once, not just twice, probably three, four or five times. You go to any party – non-realtor parties – and everyone has refinanced their mortgage. In the stock market boom, people used to talk about their Internet stocks at parties. Now they talk about real estate. The point here is that property has become more liquid. It is no longer that awkward, large asset that people are afraid to purchase, and they do so (with a fear) just like going to a dentist’s office. Ten or twenty years ago, the realtor would have to take them by the hand and guide them, in a messy process. Today it’s so much simpler. Loan approval, the loan application, the loan closing, it’s much faster today. It used to take 60 days to do these things. Now it takes less than several weeks, several days in some cases.
The technology that we’ve experienced over this past decade has been unbelievable. There’s a mortgage product for every taste, every need, that has increased the demand for home buying. The intimidation is no longer there. That’s one of the reasons why we have had this unbelievable real estate expansion. Low interest rates are another reason. Two historic lows over this past decade. But the primary reason for this prolonged real estate expansion is none of those. It’s the demographics. It’s the Boomer generation right now; they’re buying homes at a record-setting pace. The Boomers are the biggest generation ever; 82 million Boomers out there and now they’re in their peak earning years. They’re making more money now than ever before. And now they have all this built-up equity in their primary residences. What do you do when you have all this money and you’re afraid of the stock market? Where do you go? It’s a no-brainer; they went to real estate and they’ve been doing this since 1992, with more and more Boomers gaining more and more wealth – untapped equity – in their primary residence. Now we find that the Boomer generation not only is trading up to larger homes but they’re buying second homes. Last year 36 percent of all home sales were second homes. It’s never happened before in this country. Twenty-three percent were for investment. Thirteen percent were for vacation.
People are living five years longer, on average. That means there are people that are living five years longer in a house. If they’re in a house for another five years, that house is no longer available. With the great demand and lean supply, something has to give. And that’s prices!
Then we have immigration. We had record immigration in the 1970s, 1980s and the 1990s. Immigrants don’t buy a house as soon as they come to this country. It takes them a while to acclimate. So the immigrants of the ‘70s and ‘80s started buying homes in the ‘90s, which also helped fuel our real estate expansion. The immigrants in the late ‘80s and ‘90s are buying homes in this decade – at a record-setting pace for immigrants. You have retirees, the Boomers, and the immigrants, all buying homes, all creating this unusual extraordinary demand for home-buying. Last but not least, we have the Echo generation, the Boomer children. They are now first-time home-buyers. When you start looking at the numbers, that 25-year old age group has the highest home ownership rate of any 25-year old age group ever in this country. So, you take all those demographics together, the low mortgage rates in a growing economy, and the technology that has reduced cost of purchasing a home through the loan application, loan approval and loan-closing process. Then you add 9/11 which created so much uncertainty in this country. Throw in the stock market crashing.
People who have funds are nervous; they need to put it somewhere. Real estate has become the safe haven for funds. It has become the 21st century safe haven, and that’s why we have this prolonged expansion.
When I look at bubbles out there in the world – we have 66 major metro areas in this country – that over the last year experienced double-digit price appreciation. Chairman Greenspan likes to call that “froth”. In the stock market he coined the phrase “irrational exuberance.” In the real estate markets he coined the phrase “froth.” “Froth,” if you look it up in the dictionary, is just bubbles; it’s foam. There are 66 bubbles right now in this country. That’s basically what the Fed would tell you. Well, to have a bubble doesn’t mean it’s bad. In the stock market, when you have a bubble, that bubble is usually created because of psychology, because of “irrational exuberance.” That bubble can burst.
In real estate markets, when you have a bubble, it’s created because demand is greater than supply. The problem in the real estate markets today is supply – not demand. Go to Orange County, California and they measure supply not in months, not in weeks, but in days. It’s very lean, that’s why we have bubbles. It doesn’t mean that these bubbles are going to necessarily pop. The air will come out of these balloons rather than the balloons popping, and that, I believe, will create the soft landing for the housing markets over the next two to three years. I do believe that we have more oomph in real estate for the remaining years of this decade. We’ve got the strongest demand for home-buying in the last three to four generations.
When reporters come to me and they say, certainly you would at least admit that Las Vegas is a bubble ready to burst. I say, Las Vegas is the furthest metro area from a bubble bursting. You’ve got to dig deep, see why Las Vegas went up 54 percent last year. It’s not a bubble. What’s happening in Las Vegas is that people in California, where the median home price in many of those metro areas is $600,000, are uprooting their entire families and they’re moving; their leaving California. Las Vegas isn’t just the gaming industry. They’ve got one of the biggest distribution hubs now in the nation; their local economy is taking off. The median home price in Las Vegas is $280,000. So you’re going from $600,000 to $280,000. Is that a price bubble? No.
You need a perfect storm to have a local price bubble burst. A perfect storm is when you have inventories building sharply. So start monitoring your local inventories. If all of a sudden you see a sharp rise, let’s say from four to six or seven months, that’s a yellow flag that’s turning red. You need to have prolonged double-digit price appreciation. You have that here. But the most important thing you need is to have a local negative event. You need to have job losses. Boston is a good case in point in 1991.
Boston had some prolonged price appreciation and they were hit real hard. They had a 15 percent loss in jobs in the Boston metro area. That’s not a recession; that’s a depression, in Boston. That’s why they had a price bubble pop. The inventory started to increase sharply. It went from 5.5 months to 16 months within a one-year period. That’s a price bubble popping. That’s a perfect storm.
The biggest risk right now is what you’re all seeing, and that’s the speculative element that has entered our markets. We’ve got lenders that are trying to keep volume alive, and they do it by promoting loans that just may not be right for some households. I’m reminded of California where the percentage of ARMs is now over 70 percent. The percentage of interest-only loans is over 50 percent. That’s unnerving. And that’s happening now everywhere across the nation. Interest-only loans are becoming the most popular instrument out there. For sophisticated investors, that’s okay. But first-time investors – you’ve got to guide them properly, because they are depending 100 percent on future values (holding or rising) to make this investment work. They are no longer looking at cash flows, so it becomes a pure speculative play on prices – pure and simple.
And that is the greatest risk to the real estate boom today. If you have a local area that is highly concentrated with interest-only and negative amortization loans, they will be the first to pull out when good times turn to bad. And when you have a number of households and investors looking to sell quickly, that is when prices soften in a local marketplace and you can have a local bubble burst. Rather than job losses creating that bubble burst in a local area, it might be the speculators leaving quickly. That is the greatest risk.
The budget deficit, the economy, we never really mentioned it. The economy is doing well; it’s not doing great. The economy is growing at about 3.5 percent and we’re running huge budget deficits. The economy not doing great is actually good news for all of you. You don’t want the economy going off to the races and experiencing robust growth because then you’ll get higher mortgage rates. So you have the best of both worlds right now. You’ve got an economy that’s growing. The jobs are finally being created so households have the wherewithal, the financial wherewithal, to buy homes, and mortgage rates are staying very low. Long term rates are staying low even though the Fed is increasing rates. That’s a good thing that is prolonging this expansion at a very, very high pace. But the biggest risk, other than speculators, is the budget deficit. It’s almost starting to look like the Reagan years once again. We had huge budget deficits because Ronald Reagan built up the military. It worked for him because the Berlin Wall came down, the Soviet Empire was crushed, and all of those expenditures turned into what we call a “peace dividend” in the 1990s. The deficit turned into a budget surplus because we no longer had to spend money on the military. And interest rates came tumbling down starting in 1991.
Now, rightfully so we’re building up the military and spending on Homeland defense. And the deficits are climbing which eventually will exert upward pressure on interest rates. We talk about high oil prices, we talk about tax reform, we talk about Social Security reform – all of these things are potential risks to us and our industry today.
A likely scenario is this expansion will continue for a couple of more years; it’s not going to end soon. This year will be an all-time record year once again. We will have a record year in home sales. We will probably have nine percent price appreciation for the country as a whole this year. So those doomsayers were wrong once again.
We went through a recession in 2001, yet the boom continued. Mortgage rates increased in 1998 to the year 2000 by two full percentage points; yet we continued with record levels of activity. We lost three million jobs in 2002 and 2003, yet real estate markets boomed. So they’ve thrown everything at us and we’ve adapted and we’ve done very, very well.
Real estate is expanding and conventional wisdom no longer works. We have to think differently today than we did ten or twenty years ago. You’ve got to convince yourself; is this speculation? Is this “irrational exuberance” that’s driving our market like the stock market five years ago? Or is this solid fundamentals working right now? Eventually it will play itself out. Eventually all the air is going to come out of these balloons. But right now, enjoy it while you’ve got it.
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