Will Investor Explosion Burst the Bubble?

So there has been no shortage of articles on the real estate bubble here on TCI. And for the most part, I think it is clear, we are not in danger of a general bubble. But some places that is not true: In my opinion any location where houses generally sell for much more than they can rent for as is frequently seen in California, Washington and Florida you are in a “hot” market. And the danger of a “hot” market is that they tend to cool quickly. That is, that the bubble tends to burst.



So here is an article by Mary Umberger in today’s Chicago Tribune on the subject of a statistical marker which may allow us to figure out which markets are bubbles and which are not.





"Not long ago, I got an earful from real estate agents and full-time investors who complained that amateur real estate investors are making them crazy.



Sure, it's a free market and, sure, most agents are perfectly happy to work with investors. But some in the field say the zeal exhibited by the hordes of newcomer investors makes it hard for ordinary consumers just to buy houses to live in.



To condense their complaint: "They pay too much!" as one full-time investor exclaimed recently as I was researching the growing popularity of "flipping," or buying homes to resell for a profit.



Anecdotally, there was agreement that it's crowded out there. And now, there's a hard number, of sorts, to show what investors are doing to the marketplace. It's a number with potential ramifications beyond Joe and Jane Consumer's annoyance at being outbid for a Northwest Side bungalow.



As a recent report from mortgage giant Fannie Mae put it, the ranks of investors have "exploded." In a span of months, the number of homes they purchased nearly doubled, from about 5.5 percent of all homes sold in the second quarter of 2003 to 9.15 percent in July 2004, the report said.



"Three quarters back, home prices accelerated," explained David Berson, chief economist for Fannie Mae, who said he started looking for the source of the surge when it wasn't letting up last summer.



He said predictable levels of demand and low interest rates wouldn't have created the spike by themselves. "We were puzzled."



So Fannie Mae's analysts now not only suspect that investors (a term that in this case would include buyers of second homes) are pushing the prices up, but they also think they know what's inspiring them: the surging popularity of adjustable-rate and interest-only mortgages, which are touted as just the thing for borrowers who don't intend to hold a property for a long time.



I won't use the term "easy money" (and Berson pointedly didn't), but you can see where we're going with this: When the money supply withers, the investors and their upward price pressure will go with them.



Is this a problem?



"In most parts of the country, no," Berson said last week. "But there are some parts of the country, principally in the West and to a lesser extent in Florida, where there has been a bigger pickup of investors.



"At some point, investors will pull back from the market and the supply of houses will increase, putting downward pressure on prices," Berson said. "There's a reasonable chance that in markets where there has been a large investor share, there could be slowing of appreciation, and possibly outright declines in prices."



"I wouldn't put Chicago in that grouping" of potential price declines, Berson said. "But it, too, has accelerated."



In the period before that rapid national price run-up that piqued Berson's interest, "price gains [in the Chicago area] had slowed to 5 to 6 percent," he said.



"That's faster than can be sustained, but not much. And in the last three quarters, [Chicago has] seen some acceleration. In the third quarter, home prices [here] saw 8.25 percent growth. Perhaps that's driven by investor demand, but not as high as the national average."