Housing Bubble Versus Tech Bubble

Steven Taylor has an excellent discussion about the breathless coverage recently of the coming bursting of the “housing bubble” and various comparisons with the dot-com bust of the late 1990s.

[T]here are important differences. I have no doubt that there will be, at some point, a considerable cooling in the marketplace, but most of the drive in housing starts and home-buying isn’t the kind of “I bought four condos to sell” kind of activity that the story highlights. There is no doubt that there are markets in the US where insane rules apply (such as the Bay area and Silicon Valley).

However, it seems pretty clear that the main drive to buy homes is the historically low interest rates, that allow a lot of people to stop renting and start owning.

Unless a ton of people have gotten waaay over their heads with their mortgages, how will the bubble burst if housing prices cool off? I just don’t see a collapse that would be commensurate to the tech stock crash. There are real assets here which have actual usages–unlike that pile of InterZero stock that was a “sure thing” in 1998, despite the fact that company didn’t make anything and never showed any profits.

Indeed. Aside from a huge regional economic collapse, the only real danger is to those of us with adjustable rate mortgages (ARMs).

Housing in the DC area is ridiculously expensive. The 2600 square foot house that sells for $175,000 in Montgomery, Alabama would be $750,000 out in Loudoun County, Virginia and simply non-existent much closer in to D.C. without spending $500,000 to buy a property, knocking the place down, and spending another $400,000 to build it.

Those of us without huge incomes who live in these pockets must use creative financing to buy houses. In my own case, I financed 80% with an ARM that’s a fixed rate for five years and adjustable thereafter, 15% with a second trust that’s adjustable monthly (and has adjusted three or four times, all upward, since I bought 18 months ago), plus 5% down. I’m not leveraged so tightly that the adjustability of the second trust is more than a nuisance but, certainly, I’d have to move or be making a lot more money three years from now if interest rates are radically higher when it comes time to refinance.

The silver lining, though, is that it is unlikely that the sizable equity gain caused by real estate prices continuing to skyrocket is going away any time soon. The market here is not speculative but rather a true supply and demand issue. Loudoun County is the fastest growing in the entire U.S. and that doesn’t appear to be changing, given the constant growth of jobs in the government and government support sectors. There are simply more people chasing housing than there are houses available.

Update (1253): David Bernstein disagrees:

And I don’t know how many times I’ve heard that “prices may stagnate, but you won’t lose money.” In 1988, a man drove up to my parents’ house in Queens, and offered him 500K, cash, for his house. Four years later, it would have been difficult to get $325 for that house, and it wasn’t worth 500K again until 2001.

That’s true when prices are artificially high, certainly. When there’s an actual shortage of a commodity for which demand is highly inelastic, though. . . .

FILED UNDER: Economics and Business,
James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.


  1. Scott Dillard says:

    Here in the San Francisco Bay area, you can’t build anything unless you go way out or unless it’s a tiny condo in a hi-rise building. Where I live, near Berkeley, is full. The demand for housing in my area has made the house I bought for $370,000 five years ago worth $700,000 today. I’d personally like to thank the anti-growth extremists for giving me the opportunity to buy my retirement home in Palm Springs with cash – no mortgate. Thanks, guys!

  2. CrashSight says:

    This is all going to come crashing down, very, very hard. All economic indicators and forecasts show very clearly how it happened in the past and is happening again albeit on this time on a much grander scale yet in structure in the same manner.

    It’s already on the path and most still don’t see it.

    Review the facts as of 03/05:

    1. Most people have not pulled out in the mid 1/3 taken their money, and saved it. If anyone is under the delusion that their 300K house is worth 900K right now? I say try and get 900K for it, or just bank on that thought for the future for a rude awakening.

    2. There are the many who have taken insanely gross level equity loans against their properties, now these equity borrowers do not own their property outright (most likely didn’t in the first place,) and if they borrowed on inflated values? Never will. Worse yet is that these same people more than likely used the money foolishly for cars, trips, clothes, etc. (again one card pulled, take cover. )

    3. Interest rates are already rising

    4. Jobless claims are up, again. How many of today‘s borrowers are true job security?

    5. Foreclosures are rising all over the country, and at record levels.

    6. Bankruptcies are up all over the country – and new laws on books regarding them change the outcome in favor of the lenders.

    7. Household debt is at an all time record high especially in proportion to income; and most money borrowed during the past year and a half have loan amounts at record highs (and adjustable) keep in mind my interest scenario below (only 5% to 7% is a 40% increase) if adjustable? I wouldn’t want to be in that seat!

    It doesn’t take much intelligence to realize when one card is pulled from this house of cards? The house comes tumbling down occupants and all.

    There is absolutely no where for these debtors to go – think of the broad impact. Be logical and think to yourself how is this all going to be paid? and play out? Think of the economic impact across the board and various sectors. Do some research, look at the papers of major economic minds, study history.

    Anyone who has the insane belief that this smoke and mirrors vision is real (or worse those who have already gotten in deep, lured into severe borrowing to be part of this (which principle alone tells one that they will never own the place,) with loans over loans over? adjustable loans? (keep in mind a 5% to 7% interest increase is a 40% jump!) If one bought any overpriced place at 5% bad enough under any terms not the rate the price which more than overrides the low rate (another principle most didn’t understand) when the interest rate goes to 7%? Wow. Does one realize what that will do to a payment? Or what they would have to sell the same place at to just break even? Do the math people.)

    Many are going to fall, history always repeats itself. For interesting reading from the internet search, read and remember these examples of harsh reality: Search: “Bay Area Housing Crash Continues” and “Florida Real Estate Crash of 1926.”

  3. TileIndustry says:

    Crashsight makes some very valid points regarding the real estate market for those people who purchased re as purely an investment, and I’m sure there are those that did. However, for the majority of us, we purchased homes because, one, we need a place to live and two, the cost of borrowing money was less than the cost of investing the money in rent. If I were a re investor I would be getting out sometime soon, but for the rest of us we will just continue to pay our low mortgage payments and enjoy the roof over our head.

  4. Scott Dillard says:

    CrashSight – I don’t know where you are, but evidently not here in California. In the Bay Area, you CANNOT BUILD new homes near San Francisco. All the land that is empty here is parkland, wildlife refuge, etc. It is impossible to build new housing close to jobs in San Francisco and Oakland. Therefore, if you want to live here, you pay. If you want to pay less, you commute 4 hours a day, like most of my co-workers. We only owe $190,000 on this house because the rest was cash. I have NO consumer debt. My new car is paid for. My credit cards have zero balances. And I am going to enjoy Palm Springs just fine.

  5. Eric Obrien says:

    Crashsight, you made very good points. The one thing that is is key indicator of a crash, is fannie mae recently stating that they now believe almost 30 percent of all houses in the US being purchased are investment properties.

    Here in Sacramento, I bought my house two years ago. Of the 20 houses in the first phase built, 12 were either sold two or three times, or are rentals. We have gained so much equity, close to 200k, that we are going to sell, and go back to renting. We can rent our same house for 1200 less a month than what we paid in our mortgage, and we even had a 30 year fixed at 6%.

    These investment buyers are not the retired folks looking to gain some rental income, they are groups of 20 somethings who’s buddy is a mortgage broker. The all go in on a property, get some interest only, pay on tuesday, crazy loan, and buy a house. They paint the walls, throw some lawn in the backyard, and sell it to some other idiot investor.

    If you think this market will continue, then you believe this can happen. Since I purchased my home, I have seen almost a 28% yearly growth in value. If, as some believe, this growth can continue, in 30 years my house will be worth around 17 million dollars.

  6. Frank LLosa says:

    Housing bubble TSHIRT at: http://www.Franklyrealty.com/tshirt

  7. Darwin Davidson says:

    Along with the 20yrs wannabe Trumps who buys and flips property like it is burger are the baby boomers. Alarming 60% of the baby boomers have seond homes. Wait unit they retire and decide to mover back to their second homes. Imagine the number of houses that will hit the market along with already raising inventory. This is sure to send the prices down south in some areas. And a another alarming trend is decline in real income and job security. All these and other stats mentioned in this page keeps weaking the bubble even as speak. It’s a matter of when…?

  8. Jane Galt says:

    Tileguy, in all the bubble areas the monthly payment on a house is much higher than the rent, even when you take capital considerations in. That’s why people think it’s a bubble–if demand were truly the only thing driving prices, rents would be rising at the same rate.

    James, housing demand isn’t so inelastic as you think. Americans consume a lot of housing — if people in DC started downsizing to NYC-type space, I think you’d find a lot of housing was available.

    Your situation perfectly illustrates exactly why this is a bubble. The large number of people taking out ARMs that they can only barely pay as long as interest rates don’t rise more than a couple points are going to be unpleasantly surprised later in the business cycle. They’ll hold out as long as they can, of course, cutting back other expenses and taking second jobs, but eventually a good number will be forced to sell. At which point they will find that since housing prices can’t rise beyond the ability of people to make their mortgage payments, the price of their house has probably dropped significantly. Wit 5 perent down that means negative equit for many people, an ugly, ugly spot to be in. Nonetheless, they willhave to sell to get the payment off their back. Fire sale prices means lower home values for everyone else in the market.

    Manhattan certainly trumps Virginia in terms of high demand and restricted supply. Arguments such as yours were common during the 80’s (as they are now). That didn’t stop the value of my parents’ apartment from dropping by more than half in the five-year period from peak to trough (they weren’t trying to sell; my mother’s in real estate, so naturally they always know pretty much exactly what it’s worth.) At that, Manhattan is relatively protected from bubble downside, because co-op buildings generally won’t let you buy without 25 percent down and several years worth of mortgage and maintenance in the bank.

  9. Jason says:
  10. hicks says:

    I consider myself fortunate having purchased 4 rundown townhomes 1992-1997 near water in a urban area in baltimore. Purchase prices were around 35K-52K.

    renovated them and rent them currently. Prices now at 300-500K. Investor brother from new york tells me that Bubble could happen and that i should take some profit off table. Sell 1 if not all

    If you were to ask me what the renovated homes are really worth in my view, I would say 190K…this is the concern, I would not pay for these homes at the current value- in addition I can’t raise rents As much as the increase in values-

    I keep telling myself Balt wash corridor has strong job growth, and md has smart growth, and urbanization trend and keep my fingers crossed- in the meantime I enjoy great tenants, pos cash flo, very little mortgage debt and a simple lifestyle which allows me to renovate an old farmhouse full time without working for anybody.

  11. D. Bo Smith says:

    I often grapple with the possibility of a housing bubble. There is a sense of urgency to buy something before you miss out on all of the potential gains, which exacerbates the bubble.

    The risk involved with purchasing seems to outweigh the reward at this point. One thing to consider when deciding whether or not to jump in:

    Creative financing is getting out of hand. It seems that the solution to the disproportionate gains in home prices is to keep coming up with financing terms that give you less ownership and more risk. Low rates have helped the boom, but excessive ARM use, interest only loans, and now negative amortization has allowed people to buy what they cannot really afford. If this continues, they will have pay you to take out a mortgage so they can get you hooked in for future payments that you cannot afford, and people will fall for it. Additionally, people are now gambling with the bank’s money rather than their own. If there is a drop in prices of even 10-15 percent, then people will have no hopes of paying the money back, they will be trapped in their homes, and be SOL once the rates start to adjust upward. Not my idea of the American dream.

    This creativity is effectively buying time and facilitating the bubble. Once we run out of financing options, people will have to start paying for what they have. Eventually, it will be time to pay the piper.

    I often see people write these blogs out of fear and anger because they missed the boat. I have made my 100k on a home I sold two years ago. I also own a small condo that I keep as a hedge – if the home prices continue to climb, then I will still make money, but if thy plummet, then I will lose on the condo, but actually be able to afford a real house. I can’t lose either way! Good luck to those who have a dog in the fight.

  12. Bubble Bust says:

    D. Bo Smith :
    Making 100K by selling the house is a smart thing.
    Keeping the condo is not a win-win situation.
    If the prices increase you make money. But if they
    fall you are gonna loose money anyway. You may be able to afford a real house sure, but it does not make up for the money lost on the Condo. At best you
    may be equalized in gain or loss. No way it is a
    “Can’t lose proposition”.
    Smart thing would be to sell the condo now, and then
    buy a real house when the prices have fallen enough.

  13. Bubble Bust says:

    Secondly despite all the housing demand. Home ownerhsip rate has increased from 67.5% in 2000 to 69.2% in 2004. That is just an increase of 1.7%. Even though 8.7M houses were constructed in the same period.
    That is an increase of 7.5% in housing units over 2000. Adjust this number for a 4% population increase, by 2.8 (4x.6950). This means we had an effective increase of 4.7% in housing units. Should’nt have the home ownership numbers also not risen by closer to 4.7% instead of just 1.7%?

    Clearly about 3% of the total houses are now just pure investments by speculators and investors. When these propeties are put on sale, the inventory of available houses could swell by over 4 million in a matter of months.
    Just make a guess what will that do to the prices, when about 7million houses are expected to be purchased if and additional 4 million become available, Take a guess what will that do to prices.

    If every house purchased had the owner actually living in the house, there would’nt be a bubble.
    These speculative investors have created the artificial demand which has this bubble so inflated. That will also bust it.

  14. D. Bo Smith says:

    Bubble Burst:

    I agree that investors have artificially inflated the market and that these people will be the 1st to rush to sell if the market turns, but the Sixty-four thousand dollar question is: When will it happen? Nobody knows, and those who have predicted for years have either been wrong or premature with their diagnosis.

    Question for you: It seems that money went into the stock market and speculation created that bubble, then the same type of speculation has found its way to the housing market. Where do you predict the next bubble will be? Or do you think that this decline will hit the economy with depression size problems?

  15. Jake says:

    I’d guess severe recession, unless the fed government runs a really big deficit, like over a trillion dollars, which is double what they’re running now. Given that Fannie Mae and Freddie Mac will probably require bailouts once the housing bubble bursts, and all the pension funds will also require bailouts once GM and Ford and the other smokestack manufacturers finally go bankrupt, and given how generally incapable politicians are of reducing government expenditures and how the Bush administration doesn’t seem to care a fig about big deficits, this is possible. (Sorry for that run-on sentence!)

    Basically, the US has been overconsuming ever since about 1990, and it will take a big recession to work off the excesses of these debt years, especially considering that the boomers will start retiring soon. Once the housing bubble bursts, we will see people finally start saving instead of running up debt, and this will have very far-reaching impacts. Housing will decline for about fifteen years (so forget this idea of jumping onto bargains once the bubble bursts–it’s going to be a long and slow way down until inflation adjusted prices reach about 50% of what they are now, and probably the decline will be even more severe in places like Vegas) and all sorts of industries based on excess consumption will do very poorly, and also most America cities will finally declare bankruptcies. Municipal workers and people on city government pensions are going to be looking at some financial haircuts. Industries based on production should do well, especially high-technology, which is where America still has a competetive edge. Things like bioengineering, medical technology, pharmaceauticals, space-age materials and chemicals, artificial intelligence, etc. It’s pretty hard to invest in those areas, since it difficult to predict which individual companies will do well, but those are definitely great places to be if you’re a worker or plan to start your own business.

  16. D.Bo Smith says:

    I just calculated the cost of the house I am renting in Arlington, VA versus what it would cost to buy. The Tax value is $540k, and a conservative sale estimate would be around $600k (most are going for around 100k over tax value after being bid up). I am paying $1475.00 per month to rent it. A mortgage on $600k assuming a 30 year fixed rate of 6% with 100% financed would break down as follows:

    Mortgage Amount $600,000
    Monthly Payment $3597
    Monthly Tax $400 Approx
    Total $3997

    30% tax back from Interest $1079
    write off

    Total real payment $2918

    By the time I would pay repairs and maintenance, it would end up costing me about $3200 per month That is $1725 per month or $20,700 per year saved by renting with no risk (only about a 4% gain per year, but even the optimists predict a flattening out from this point going forward.) There was money to be made in the housing market, but this is the smartest investment at this point. All of the above figures are conservative estimates, they do not account for 2nd trust with a higher rate, and do not account for gains that could be made on the saved amount. Enjoy these numbers!!