John M. Lee: Real Estate Bubble Revisited

Once again, the topic of a possible real estate bubble has resurfaced in the news. With the median price of a home going up by an average of 20 percent this past year, the major press has been buzzing with the possibility of a bursting real estate bubble.

Recently, there was a front-page article on this topic in the San Francisco Chronicle and local CBS television station had a segment interviewing several people on the topic.

Some sellers said they felt there was a bubble and were now selling their property and a real estate agent who was interviewed said prices are too high and that they will fall.

On the flip side, Paul Erdman, an internationally known and respected economist, does not feel there is a bubble and another leading economist, Professor Edward Leamer from UCLA's Anderson School of Business, recently reversed his position from being bearish on real estate to stating that there is not a real estate bubble.

So who do you believe and how can you determine if there is a real estate bubble?

First, let's define what a real estate bubble is. When prices increase rapidly due to speculation or unsound economic principles, it can create a bubble, which can pop, causing prices to fall precipitously, if market conditions change in a negative manner.

This happened in the stock market a few years ago when the Dow Jones Industrial Average (DJIA) declined about 30 percent and the NASDAQ decreased 70 percent from its peak in March of 2000. Because investors were caught up with the Internet frenzy, they paid high prices for stocks without any proven track record and no earnings.

A bursting bubble could, of course, happen in our real estate market, but I do not see that happening.

We discussed the bubble theory in this column in October, 2002, and June, 2003. I felt that at the end of 2002 the chance for a bubble was slight due to economic uncertainty and the possibility of going to war in early 2003. In June of 2003, I felt that the danger of a bubble was over and that there was no bubble on the horizon.

Now, it is two years later and prices have gone up substantially.

The economy is stronger. The war has been fought and (I think) won - the only uncertainty is when we will be pulling out of Iraq. The interest rate has been increased slightly by the Federal Reserve Bank, with little affect on the long-term mortgage rate. Inflation is in check and the dollar is weak against other foreign currencies, meaning more exports and foreign investments in our assets. All these are positive signs to sustain our market.

We had a banner year in 2004; prices appreciated about 15 to 20 percent with good activity. This year, though, our volume of listings as compared to the same period last year is down about 20 percent, meaning less sales and more competition for the same listings. We still have a great amount of buyer demand - with limited supply and constant demand, simple economic theory indicates that prices will go up.

We will see how the market develops this year as time goes by. But all indications thus far lead me to believe that there will be no real estate bubble in San Francisco. There are just not enough available properties to satisfy the demand.

On the other hand, we cannot expect double digit appreciation each and every year because prices would increase faster than what buyers could afford to pay for the properties on the market.

So, the local forecast for this year is for moderate appreciation, somewhere in the neighborhood of 5 percent to 8 percent, with no bubble in sight.

John M. Lee was recently honored at the Pacific Union conference in San Diego for selling the most properties in San Francisco. If you have any questions regarding real estate, call him at (415) 447-6231 or e-mail at johnlee@isellsf.com.