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Too hot to handle?

Money | A slew of recent studies show that the U.S. housing market is not just hot but on fire

Issue: "MS-13: Criminals next door," June 18, 2005

What's hotter than summer in the Southwest, more coveted than Red Sox tickets in Boston, and more popular than Bill Gates in Seattle?

The answer is a typical house in each of those markets. A slew of recent studies show that the U.S. housing market is not just hot but on fire. So much so that some experts are calling it a wildfire and warning that people might get burned.

The National Association of Realtors reports that nationwide the median price of an existing home in April was 15.1 percent higher than it was in April 2004, jumping from $179,000 to $206,000. That's the biggest one-year jump since 1979. The Commerce Department, meanwhile, reports that new homes sold at an annual rate of 1.3 million units in April, a record and a jump of 13.3 percent over April 2004.

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These numbers remind many analysts of the Nasdaq, circa 1999. Prices were rising quickly and tech-stock gurus were assuring investors that a "new economy" was turning traditional gauges of value like price-to-earnings ratios into outdated relics. Investors began to feel entitled to double-digit annual increases and even borrowed to buy more tech stocks-until the tech bubble popped in 2000.

The housing market, these analysts say, is in a similar bubble and is due for a similar correction. "When this market adjusts, it's going to be painful," said UCLA economics professor Edward Leamer, who warns of a housing bubble in California. "Borrowers are getting in over their heads, and lenders are too."

Other analysts, however, are bubble skeptics. Houses aren't like other investments, they argue, because to most people a house is more than a money machine.

Nobody, for example, lives inside his stock portfolio. A classic bubble bursts when owners of a red-hot asset become nervous and all begin trying to sell at once. But homeowners aren't likely to panic and rush "home, sweet home" onto the market if prices fall a bit. Bubble skeptics also point out that personal incomes, a key support for housing prices, have risen strongly over the past two quarters.

Still, few doubt that speculative fever is taking hold in some regions of the country. "Flipping," or buying a home and then selling it quickly for a profit, is becoming more common. (Flipped houses now account for 11.5 percent of home sales in Las Vegas, for example.) Adjustable-rate mortgages are also growing in popularity, as is the practice of borrowing against a home to pay for consumer spending. (In 1999, Americans borrowed $266 billion against their houses; by last year that number was up to $705 billion.)

These practices make the housing market in some areas-particularly the West and the Northeast-more like other investments and more prone to bubbles. If interest rates rise, as they almost certainly will, or prices cool, the speculators and adjustable-rate borrowers will take a hit and some may be forced to sell.

"At a minimum, there's a little froth in the [housing] market," Federal Reserve chairman Alan Greenspan told the Economic Club of New York last month. "We don't perceive that there is a national bubble, but it's hard not to see that there are a lot of local bubbles."

How that "froth" will taste may depend a lot on where you live, how you view your house-and how you're paying for it.

Timothy Lamer
Timothy Lamer

Tim is managing editor of WORLD magazine.

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