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Pop Goes the Bubble?


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MARC HOLZMAN has purchased two homes in San Diego in the past two years. He lives in a four-bedroom home in Bay Park and has renters in a three-bedroom house in Point Loma. Needless to say, he’s pleased with the handsome increases in his property values.

 He’s not alone. The median price of homes countywide has doubled to about a half-million dollars in the past 10 years, handing many San Diego homeowners a windfall in increased equity. “Get in while you can,” advises 36-year-old Holzman, who’s now a real estate agent at Shelter Island Capital Inc., after more than a decade of working in the recreational marine and sportfishing industries.

His boss is taking a decidedly more conservative approach, however. Ben Murphey, 32, rents and sees no reason to risk being highly leveraged in a market that some economists predict is headed south.

“I’m renting a house in Point Loma, with a view of downtown and the bay, for a fraction of what it would cost me to own it,” says Murphey, a licensed real estate broker and president of Shelter Island Capital. “I don’t reap the benefits of owning by getting a tax deduction and realizing any gain in equity, but I’m willing to accept that for now.”

Sure, he’s missed some chances at possibly making a quick buck buying and selling, or “flipping,” but he’s not looking back. The market is cooling, and if it tumbles, he’s likely to get a better deal on his dream home near the beach. Unlike Holzman, Murphey is married and has a baby, so he’s not comfortable with the risks of speculating in real estate.

“My objective is to own a house where I want to live permanently,” says the avid surfer. “I’m concentrating on my business, saving up money to put down enough on a property so no matter what happens in the market, I’ll still be able to make those payments.”

Holzman and Murphey illustrate the differing perspectives on the direction of the residential real estate market. On the one hand are those who insist there is a classic real estate bubble, that homes in many areas of the country—particularly California— are overvalued, and as with the stock market in 2000, a significant pull-back is the only feasible outcome. This, in turn, could push the economy into recession.

Then there are those who contend there is no bubble. Yes, the market is likely to taper off, but economic prosperity will sustain modest increases in housing valuations, they say. Meanwhile, Joe Homeowner is wringing his hands over whether to hold, fold or use his swelling equity to buy investment property while the market still has legs.

Dean Baker, economist and codirector of the Center for Economic and Policy Development in Washington, D.C., is one of the more prominent bubble adherents. He trumpeted to the national press that he sold his suburban home more than a year ago, just as he wisely emptied his stock portfolio in 1999. Baker now rents while he waits for the housing market to correct itself and for a new buying opportunity to emerge.

In June, he told Business Week the increase in home prices in the past seven years outpaced the rate of inflation by 60 percentage points. “This kind of run-up becomes unsustainable,” he said, comparing it to the stock market crash in 2000. “A decline in housing prices would have a very serious effect on the economy.”

His position was bolstered a few days later by midyear reports from Merrill Lynch, the University of Maryland and the Anderson School of Management at the University of California, Los Angeles. The reports told of impending doom in the residential real estate market and a potential national economic downturn. Merrill Lynch analyzed housing markets in 52 large cities, identifying 30 showing signs of overheating. Six cities in California —San Diego, Riverside/San Bernardino, Los Angeles, San Francisco, San Jose and Sacramento—were all considered “white hot” because prices have increased faster than local incomes. The construction of new homes is outstripping the natural growth of the population, and the markets are “heated beyond sustainability,” the report concluded.

Similarly, the UCLA Anderson Forecast acknowledged that “the California economy . . . has been showing very solid signs of growth.” But lying just below the surface are troubling signs “of an economy not at the start of a new expansion but very near the end of an old one,” says senior economist Christopher Thornberg. Citing the slow growth of personal income and an imbalance in the relationship between taxable sales and wages, Thornberg believes California’s current economic growth is in a fragile condition. Employment growth in the state is currently being driven by consumer spending, which is being driven, in turn, by the wealth effect of a hot real estate market. This is about to end, he predicts.

“Even if the real estate market doesn’t pop, the fact that it has to start cooling is enough to slow the process down,” Thornberg says. “Prices don’t have to go negative to have an impact; just 15 percent to zero percent is enough to start the dominoes falling.

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