Dr. Duru Has Moved Into the Housing Bubble

By Dr. Duru

November 30, 2005

After spending months railing against the housing bubble, including its prime creator, Mr. Greenspan, yours truly, has finally succumbed to the sweet siren song of the housing bubble. I have picked up my belongings from the West Coast and settled into my favorite city of Atlanta. My timing has proven impeccable as usual. I joked with friends before that by the time Dr. Duru finally decides to buy a house, they will get their signal that the housing bubble/boom is just about over. Sure enough, we have read plenty of warnings from the homebuilders that the housing market has begun to cool off. Yet, there seems to be an interesting bifurcation in the market. The resale market seems to have noticeably cooled off while the market for new homes continues to be red hot. I observed these differences in definitive terms in Atlanta. Homeowners trying to sell their homes were scrambling, working hard, and leaving listings open for weeks and months. Builders of new homes could not keep up with demand, selling dirt and a promise to get a new home up as soon as possible. I ran into estimated delivery times as late a Spring, 2006. I have no idea how to explain this on the national level, but I can comment on what I have seen in Atlanta. There remains plenty of land in Atlanta for developing and building. This helps to keep the costs of new homes "reasonable" and within reach of the average homebuyer while allowing builders a fighting chance to meet demand with supply. At the same time, these same builders are stoking demand by offering a vast array of incentives, bonuses, and related enticements to keep the buyers coming. Current homeowners are trying to sell their homes at the price of new homes, and they are discovering that buyers would rather have a new home for that same price. The net effect is that homebuilders cannot keep enough inventory and the market for resales has become somewhat depressed.

The Fed has now complicated the story. When the latest minutes came out this month, the market noted that a few Fed officials had become a bit uncomfortable with the prospects of pressing the pedal to the metal on interest rates. Suddenly, the market is back to anticipating the end of interest rate hikes, and this has given new hope to the market by slowing the recent rise in long-term rates. (The recent run in gold to 18-year highs and the new run in commodities like copper and steel suggest that the drama on inflation is not yet over!) And now the latest housing data confirms that the new home sales market remains red hot: new home sales made their highest monthly jump since 1993. While I would prefer to measure the year-over-year change, the housing pundits seem to think this move is a big deal. It certainly provides a stark contrast to all the "bad news" we heard in prior weeks. Housing starts and building permits fell significantly in October, sales of existing homes finally fell last month and inventories continue to rise, and homebuilders have generally been issuing cautious guidance about future sales prospects. But the housing bulls can continue to take comfort because even with this one-month weakness, the activity in the real estate market remains quite robust in historical terms. Even the homebuilders have not uniformly sounded the alarm bells. For example, while Toll Brothers (TOL) delivered the market's most disappointing news, Centex (CTX) remains quite upbeat. It seems higher-end homes are taking the brunt of the slowdown. You can observe the difference in the homebuilder stocks and see that some bifuraction has descended upon the homebuilders themselves.

It seems 2006 will be a make or break year on this story. If rates continue to rise into 2006, we should expect further slowing in the real estate market. But I think it is still too early to know whether this slowing will bring the real estate market back in line with historical norms. For example, if interest rates remain lower than historic norms, it stands to reason that rate-sensitive economic activity can remain relatively robust. We can be sure that as long as real wages remain stagnant AND rates rise, homes become less and less affordable. The fall-out from this process will hit first and hardest on the homes that are currently the least affordable: high-end homes and high-flying markets. Regardless of what happens, you can remain assured that I will continue to call a bubble a bubble when I see one...even if I have haplessly stumbled into one myself!

As always, be careful out there!

DrDuru, 2005