Bubbles |
Director, Washington Center
for Real Estate Research
Washington State
University
New Year’s brings out the
champagne, and prayers for better things to come in the new year. It also brings questions about what to
expect in the year to come. This
time around there are continuing discussions about the supposed real estate
“bubble”.
Before addressing the issue of
a bubble directly, it is important to recall that real estate is historically a
highly cyclical industry, tied most heavily to mortgage interest rates and
credit availability. Those
financial considerations are reinforced with traditional demand factors –
demographics and job availability on the residential side and employment and
sales on the commercial side. While
both residential and commercial real estate markets are cyclical, the cycles do
not correspond exactly. High
vacancy rates in many types of commercial property and declining rents foretell
a challenging year in commercial real estate in 2003. The prospect of somewhat higher mortgage
rates may slow residential real estate from the torrid pace which has prevailed
in 2002,but a generally stable, strong market is expected by most
experts.
Returning to the concept of
bubbles, however, the situation in real estate is very different from strictly
financial assets. Two years ago the
high-tech sector truly created a bubble in the stock market. After years of warnings (or so it
seemed), the investors concluded they could not continue to bid up the values of
businesses that had never turned a profit, and which offered little hope of
becoming profitable in the near future.
Withdrawal of investments sucked the energy from the market and the
bubble suddenly collapsed, resulting in a NASDAQ which is less than half its
former level.
Real estate, on the other hand,
is much more than a paper asset.
Households continue to need residences. Businesses continue to need space for
their operations. The physical
properties are real, not illusory.
This does not mean, of course, that values may not decline, but even in
the early 1980s when mortgage interest rates soared to 15 percent and home sales
activity fell to half the level of a year earlier, home values declined very
little, on average. Certainly, some
buyers who purchased homes in the last days of the boom saw their values decline
significantly, but most home owners emerged from the down market relatively
unscathed. In addition to the
continuing need for housing, the transaction costs and holding periods for real
estate investments make it unlikely to move swiftly away from real estate, and
it was the rapid departure from tech stocks which really caused the bubble to
burst.
Individual submarkets may
experience greater challenges than others, with the higher-cost neighborhoods in
the greater Seattle market having greater risk than less expensive homes or even
than the top of less inflated markets.
Many parts of the state, especially rural areas and urban communities in
Eastern Washington have not experienced the run-up in values or overheated
activity which would be conducive to the formation of a bubble, even a small
one. There may be a market
correction in the months ahead, indeed the prevailing selling prices of real
estate may decline somewhat, but any reduction in activity or prices are not
expected to collapse the market or burst any hypothetical
bubble.
They say for the champagne to
retain its fizz, it needs to be served in the right shape glass. While we may
not have the ideal glass (economic recovery is sluggish), we certainly have an
environment where real estate should remain effervescent in
2003.
Statistics on Washington’s housing market and other useful
information are available on WCRER’s Web site: www.cbe.wsu.edu/~wcrer. For other
information on real estate markets around the State of Washington, or general
information about the real estate industry in the state (excluding legal
questions), readers can reach the WCRER at 1-800-835-9683.
January, 2003