Pop Goes the Real Estate Bubble?

There is a fierce debate underway between optimists and pessimists about the future of the red-hot U.S. housing market. Last week, the International Monetary Fund (IMF) claimed that the market could be headed for a fall. It reported that real estate bubbles in industrialized countries have a 40% chance of being followed by a sharp drop in prices. In other words, the IMF thinks there is a strong chance that real estate will go bust. In the other corner is the PMI Mortgage Insurance Co., who reported in February that the probability of real estate prices dropping more than 10% is about 5.94%, meaning a 1 in 17 chance that housing prices will crash.

These conflicting predictions put U.S. homeowners, and those who would like to be, in a quandary. Which side to believe -- the pessimists or the optimists? Data from Gallup's annual Economy and Personal Finance survey* show that Americans, though they've been shaken by the recession and unemployment, are coming down on the side of optimism.

Buy, Buy, Buy

As every real estate agent will tell you, a house is the biggest investment most people will ever make. So the danger of making a mistake is considerable. But as Tim Burroughs -- a Boise, Idaho, real estate agent with 20 years of experience -- said, "Now is one of the best times we've ever had for buying a house. The bubble is not bursting; that's just hype for headlines." The vast majority of Americans seem to agree. In the April 7-9 poll, 81% of respondents said now is a good time to buy a house. Sixteen percent feel that now is a bad time to buy a house, and 3% have no opinion.

Scraping the Bottom

Even those homeowners who barely passed seventh-grade math can tell you, in detail, what a 0.05-point difference in home interest rates means to their mortgage. According to Burroughs, big hikes in rates aren't historically unknown. "I was doing loans when interest was 18% and people were buying buy-down points. We've been spoiled by below-market rates." Although 18% is nearly unimaginable, most Americans doubt the days of 6% interest rates are here to stay. Forty-seven percent told Gallup they think rates will go up in the next six months. Twelve percent said rates will go up "a lot" and 35% say they'll go up "a little." Only 16% of Americans think rates will drop --14% say rates will go down a little and 2%, think rates will go down a lot. Thirty-five percent feel that interest rates will remain the same over the next six months. "I'd say, get in and buy a house while you can still afford to," said Burroughs.

The U.S. Department of Commerce reported that housing starts in March were, unexpectedly, up by 8.3%. However, permits for houses were down by 18.5%, which may be a better indicator of consumer confidence in real estate. It's possible that people think that if they don't buy right now, they will have to pay more in interest very soon.

Bottom Line

So who will turn out to be right, the optimists or pessimists? Inevitably, it will be the pessimists -- interest rates are bound to rise at some point and housing prices will eventually fall. The real question is when. You might have 10 days, 10 months or 10 years before the bubble bursts, but Burroughs has his own suggestion for reducing your risk. "Arrive planning to leave. [In other words, buy your real estate with a plan to sell it.] A UPS driver told me that, and it's true."

*Results are based on telephone interviews with 1,018 national adults, aged 18 and older, conducted April 7-9, 2003. For results based on the total sample of national adults, one can say with 95% confidence that the maximum margin of sampling error is ±3%.