John M. Lee: Real Estate Bubble - Or Not?

We are certainly living in confusing economic times like we have not seen before. We have had the largest drop in stock prices ever, even more than during the Depression Era by some measures. And yet, our real estate prices have held up extremely well and have even gone up in some areas.

In many of the leading economic publications, there has been much discussion regarding the possibility of a real estate bubble, much like the stock market bubble, just waiting to pop; resulting in plunging real estate prices.

But our Federal Reserve Board Chairman Alan Greenspan testified before Congress in July that "We have looked at the bubble question and we've concluded that it's most unlikely." He said the driving forces behind the continuing strong prices of homes are low interest rates, scarce buildable land and strong demand fueled by immigration.

In these uncharted economic times, whom do you believe? If you had to buy or sell, are you better off waiting or should you do it sooner rather than later? How do you make these decisions in uncertain times?

If we look at history, real estate typically has been a lagging economic indicator, following the stock market up or down about 9 to 12 months later. The reason being that the stock market is a leading indicator, meaning that when stocks go up, investors are betting that the companies will make more money in the near future. If this is correct, it leads to a stronger economy. With a stronger economy, there are more jobs created, less unemployment and more competition for labor, resulting in more confidence and buying power for consumers. And with that, consumers go out and buy large big-ticket items, such as real estate, leading to higher prices.

The opposite is also true. When the stock market goes down, it is predicting that the economy will weaken. Companies make less money and start to announce layoffs, making consumers less confident about getting their next paycheck, resulting in people not wanting to obligate themselves to large financial commitments, such as a 30-year mortgage. This leads to less demand for real estate and thus lower prices.

If we believe historical data, which is consistent with the bubble theory, real estate prices will come tumbling down in the next 12 months. However, history does not dictate the future. If it did all the time, then it would be easy to determine what our actions should be and we would all be rich by now.

Today's real estate market is different from yester-years. Our interest rates are at 40-year lows. Our real estate market feels the impact of the securities market within a short period of time. Our real estate cycle, which historically has been very long, approximately 10 years from peak to peak, has been compressed because of today's technology and the speed with which financial information can be disseminated. What happens in the stock market can have an effect on our market within a short period of time. And thus the fact that our real estate market has not tanked nearly as much as the stock market leads me to believe that our market shall be fine in the long run. There might be some short-term fluctuations in the coming months, more so from external factors rather than economic reasons.

One event to watch out for is whether or not we go to war with Iraq. Traditionally, if and when we go to war, our nation will be fixated on the progress of the battles for the first few months, causing the real estate market to slow down because of uncertainty. Also, if a terrorist attack were to occur again, it will dampen our market. And in the unlikely scenario that our interest rates rise, it will also hurt.

In MBA school, we learn of a decision-making process called risk analysis. It involves assigning probability factors to the occurrence of certain events and making a decision based on the possibility of it happening. By using that type of method, I believe that there is a better chance of a 10 percent drop in real estate prices than a 10 percent increase in real estate prices within the next year or so. In the long run, however, real estate will do fine and is probably one of the best investments you can make.

If you are a seller needing to sell within the next six months, I would recommend that you put the property on the market sooner rather than later. If you are a buyer, I would look for opportunities and prepare offers accordingly. If you plan on staying in that property for the long term, I would not hesitate to buy now and lock in today's low interest rates. If you are thinking about staying only for the short term, like a year or two, I would not buy at this point because the risk is too great. If you own a home and plan on staying there for a while, now would be a great time to review your loan terms and perhaps refinance.

John M. is a top broker at Pacific Union, specializing in Richmond and Sunset district properties. For questions regarding real estate, call him at (415) 447-6231 or e-mail him at johnlee@isellsf.com.

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