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Is This House Worth $1.2 Million?
No, we don't have a housing bubble yet. But if the frenzy doesn't end soon, we will. Then, watch out.
FORTUNE
Monday, October 28, 2002
By Shawn Tully

In these turbulent times, it's a relief to ponder the things you really can count on. The recently departed, love-'em-or-hate-'em New York Yankees will roll into the playoffs again next season. Our foreign policy will drive the French to distraction. The new Harry Potter book will rule the bestseller list. Sunday night's big guy, Tony Soprano, will keep trudging through therapy. And your house will keep rising in value.

That last point is no trifling matter. Like everyone else, you watched your 401(k) shrink dramatically and cursed the bleeping broker who swore your tech stocks would soon roar back. But your five-bedroom colonial on half an acre doubled in price in just five years, and you're expecting it'll double again in the next five years, sure as Yankee pinstripes in October or Gallic pique.

It probably won't happen. And that's a damn good thing. Put simply, U.S. housing prices are stretching the outer limits of what's reasonable and sustainable. Instead of cooling down, prices keep hurtling upward, defying the laws of economic gravity just as grievously as those unmentionable dot-coms once did.

In other words, what looks like a gift to homeowners today is potentially a recipe for disaster later on: If the boom persists, housing will become so overheated it'll pull the entire economy into dangerous, fragile territory. In a year or two, prices will fall with a thud, unleashing a double-dip recession that will pummel home prices even more. "Every day prices rise, the risk gets greater that a bubble will form--and unwind in an ugly way," says Mark Zandi, an economist with consulting firm Economy.com.

From these heights, it's hard to look down. Since the boom began in 1995, housing prices have jumped 51%, or 32 points above inflation. The run-up has added $50,000 in wealth, on average, for every one of the nation's 72 million homeowners. In many markets the gains are even more extraordinary. In Boston, home prices have risen more than 110% since 1996, to an average of $398,000. In San Francisco and San Jose, a three-bedroom ranch will run you about $500,000, almost twice what it fetched seven years ago. Even in post-Sept. 11 New York City, housing galloped 11% in the year ended June 2002. And amazingly, at those nosebleed levels, prices keep climbing.

Fortunately, it's still too soon to announce the B-word. For the nation as a whole, no housing bubble exists. By FORTUNE's estimates, homes across the country are overvalued by a modest 5% to 10%. But to paraphrase former House Speaker Tip O'Neill, all housing is local: America is a mosaic of urban and suburban areas governed by their own quirky dynamics of employment, incomes, and desirability. That 5%-to-10% figure is a composite of a vast range of markets where values fall above, below, and precisely at the prices the fundamentals would dictate.

Right now, the biggest danger lies mainly with cities on the two coasts--the aforementioned Boston and the San Francisco Bay Area as well as New York, Miami, and Portland, Ore. Each is trapped in a classic paradox: Prices keep booming while jobs are vanishing. Clearly that can't last. The frothy markets are 12% to 22% overpriced, according to a study by Dr. Michael Sklarz of FNIS, a provider of real estate data to lenders and developers. Pricey? Yes. But we're still not talking Nasdaq 5000 or even the real estate market of the early 1980s, when homes in Boston and San Francisco and San Diego were 30% above their basic value. Those were bubbles. We're not there yet.

If housing acts sensibly from here, prices will adjust smoothly by dropping modestly in the strongest markets and moving sideways for two years or so in most places. As the economy recovers, interest rates will inevitably rise from current bargain-basement levels. Homeowners will react to steeper monthly payments logically--by refusing to pay ever higher prices for new homes. (That adjustment has already begun in the commercial market; see The Property Master.)

What that means, of course, is that future returns on your home won't begin to approach the stupendous gains since the mid-1990s. Today most houses are like high-P/E stocks: They're already too expensive to make you a lot of money. The upward march of property taxes--they rose 6.5% last year--isn't helping matters. Over the next five years you'll do well if your house appreciates in the low single digits.

Homes for Sale

San Francisco, California
BOHEMIAN CHIC! This cozy, remodeled Victorian with three bedrooms, two baths, and fireplace won't last.
1996 for $285,000
2002 for $1,195,000
319%

Mill Valley, California
RANCH APPEAL! Basic but classic 1600 sq. ft. starter house in leafy Marin County. A hot ticket!
1997 for $432,000
2002 for $969,000
124%

Newton, Massachusetts
BOSTON BRAHMIN. Quaint 1930's three-bedroom on one-fifth acre of prime suburbia. A charmer!
Worth in 1997: $304,900
2002 for $525,000
72%

Dallas, Texas
LONE-STAR MEDITERRANEAN! A Texas-sized 3600 sq. ft. townhouse in tony Turtle Creek.
1999 for $750,000
2002 for $920,000
23%


http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209840



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