It’s virtually impossible to turn on the nightly news or pick up a financial newspaper nowadays without seeing mention of the term "housing bubble." But what exactly is this bubble we keep hearing about?
We're all familiar with bubbles and what happens when a bubble pops. You’re left with residue, a sticky gooey mess on the floor. Everyone has heard of the "dot.com" bubble, and that’s an example we’re probably most familiar with. The NASDAQ stock index had lots of dot.com companies in its index. That particular index more than doubled in value over a one year period to reach a peak of 5132.52 on March 10, 2000. Then it began a decline and at its low, the value was 21.6% of the index at its peak. Now, that’s a bubble, a sticky gooey mess on the stock market floor.
Now, financial experts are talking about a "housing bubble." If you think million dollar homes will someday be selling for $200,000, that would be a bubble. But has there been such a bubble in the past?
Using statistics from the National Association of Realtors going back to 1968, the median sales price of existing homes has never shown an annual decline. The slowest price increase occurred in 1989, an increase of only 0.22%. That is what we call a slowing price appreciation, not a bubble. Prices still went up although only slightly.
When talking about a housing bubble, the experts say that they don’t necessarily mean a national housing bubble, but there will be pockets of price decline and that there has been depreciation of home values not too long ago. They’re usually talking about California as an example.
So what did happen in California and was there a housing bubble? The median price of California homes hit a peak in 1991, followed by five consecutive years of declining home values. At the bottom, the median price was 88.34% of the peak, almost a twelve percent loss in value.
Bubbles by definition lose about 80% of value, not twelve percent. And while the difference seems moot, the term "housing bubble" has such a dramatic ring to it, doesn’t it? It even sounds kind of scary. Plus, it makes for great press. It makes headlines and sells newspapers.
Is it possible that house values will decline soon? No one can really predict. What does history show? Returning to California as an example, the median price has increased 72% over the most recent three years. Between 1974 and 1977 California median prices increased by 80%, faster appreciation than they’re experiencing now. Three years later, median prices had increased another 60%. Ten years after that, home prices had doubled again. Then there were five years of declining home values for a total twelve percent loss in value.
What’s different this time? Numbers. Expressed in dollars, the recent increases in value seem extreme. As a percentage of the home’s cost, appreciation has been more rapid in the past and there could be many more years of appreciation in the future but no one really knows.
If no one can predict if or when prices will decline or by how much, how do you protect yourself? You do it the old-fashioned way. When you buy a home, buy one you intend to own for a long time. The cost of a house isn’t just the price you pay for it and price may not be as important as your carrying costs. The largest cost is your mortgage payment. With low interest rates, people can afford higher priced homes because their payments will be low. If possible, skip the "first-time homebuyers" house and buy the "move-up" house instead. That saves you one move, saves you costs, and puts you in a position where you don’t have to sell.
You see, how much your house goes up or down in value each year doesn’t make any difference at all - until you have to sell it. Then, if you’re selling in a slow market, you’re also buying in a slow market and if you’re buying in a hot market, you are also selling in a hot market. It balances out, provided you have enough equity to make your next purchase.
So in conclusion, there probably is not a housing bubble in the way that there was a dot.com bubble, however, it is quite likely that there will be a time in the future when values decline, at least in certain areas. It could be in a year or it could be in twenty years.