Analyzing Housing Bubbles

John Burns: With all the press on housing bubbles, I thought I would clarify a few things.

By John Burns

August 23, 2004 (All day)

With all the press on housing bubbles, I thought I would clarify a few things. In the past, the home building industry has been prone to two types of housing bubbles: 1) Price Bubbles and 2) Supply Bubbles.

1. Price Bubbles generally occur in the expensive, supply-constrained markets, such as California and the Northeast. Builders in these markets can't meet demand, so surges in demand tend to result in years of rapid price acceleration. The price acceleration often becomes too rapid because home buyers and investors incorrectly assume that what happened last year will happen in perpetuity. Price bubbles can be fueled by declining mortgage rates, which is what The Wall Street Journal and others have been warning about for years.

2. Supply Bubbles generally occur in the inexpensive, supply-plentiful markets, such as Arizona, Atlanta and parts of Texas. In the past, builders in these markets have grown their businesses too fast during strong economic times, eventually resulting in oversupply.

Some markets, such as Denver and Las Vegas, can exhibit signs of both overpricing and oversupply. These markets are particularly difficult to analyze and can experience strong sales in some submarkets while sales in other submarkets are extremely weak. Those who have stayed the course in these markets, however, have generally done quite well.

Additionally, significant fluctuations in mortgage rates can change home prices dramatically in all markets in the country. Any discussion of a national housing bubble should be a discussion of mortgage rates and capital availability only, because all other factors are local in nature.

Please don't fool yourself. I have heard more than one builder state that the housing market is no longer cyclical - that somehow disciplined capital sources and home builders have created an environment where home prices can only go up in perpetuity. While builders are much better managed than ever before, and the 1989 FIRREA Act wiped out aggressive lenders, optimistic consumers can push prices beyond what is reasonable and optimistic builders can build more homes than are needed. These are the risks of being in the home building business - deal with them appropriately.