The median sale price of a home in Milwaukee County jumped 52 percent from $104,000 in 2001 to $154,700 this year. Not a bad return on investment. That dramatic increase reflects how the demand for housing has exceeded the supply in the southeastern Wisconsin market. Indeed, it has been real estate, fueled by low interest rates, and not the stock market, that has carried the U.S. economy since the dot-com crash, the terrorist attacks and the recession that followed.
However, several signs are pointing to a new kind of housing market, one in which the demand is cooling. Many Realtors say houses that would have been sold quite quickly just six months ago are now sitting for sale much longer.
A plethora of economic stars are lining up to form the outline of a housing bubble, at least on the coasts: consumer debt is at an all-time high; bankruptcies are at record levels; interest rates are ticking upward; wages are stagnant; consumer confidence is dipping; and fuel costs are at record highs.
Indeed, the National Association of Realtors’ U.S. Housing Affordability Index is at its lowest point since 1991, meaning wages and home prices are out of whack.
The supply of affordable homes finally appears to be surpassing the demand.
Is the party over?
The U.S. Department of Commerce reports that national sales of new homes dropped 9.9 percent in August to 1.24 million units. At the same time, the supply of new homes on the market rose by 2.6 percent.
Michael Sadoff, an investment manager at Glendale-based Sadoff Investment Management Inc., says he has had conversations with clients in Los Angeles who lead him to believe the residential real estate market there has reached a bubble level similar to the 1990s tech boom.
"In L.A. in the 90s, all people wanted to talk about were tech stocks," Sadoff said. "Now all they want to talk about are homebuilding."
The conventional wisdom is that the East and West Coasts are more prone to housing bubbles than the stable Midwest. That is why many large real estate investment companies, such as Northwestern Mutual Life Insurance Co., have ignored the Midwest and have gobbled up properties in the East, the South and the West over the past five years, seeking the liquidity of reselling those properties with large returns on their investments in shorter time frames.
That land rush is reflected in the rapid growth of housing stocks, Sadoff said. Those stocks have posted near-vertical climbs in recent months and years in a parabolic curve, which has previously pointed to bubble-like conditions, he said.
Many economists have compared the parabolic curve to the stock market conditions before the tech bubble burst in the mid 1990s and before the Great Depression, Sadoff said.
Sadoff points to the Standard & Poor’s Homebuilding Index over the past five years, which has risen about 300 percent since 2003. That climb, Sadoff and others say, shows bubble-like conditions.
"To us, it looks like the late 20s," Sadoff said. "In the next four to nine months, the housing market will slow. And that means that the economy will start to slow. It doesn’t have to happen. It could be delayed by a few years. But it could be quite nasty."
The parabolic curve has almost reached its peak, Sadoff said, but it could continue to climb for a short time if interest rates remain low and innovative mortgage products remain attractive to homebuyers.
Federal Reserve Chairman Alan Greenspan recently warned that "characteristics of bubbles" are embedded in the nation’s housing market.
Sadoff believes the Milwaukee economy could be hurt by the deflation of the housing bubble in other parts of the country.
"The housing bubble has infected the potential health of the entire banking system. The nation’s banks are now in a vulnerable, over-extended position with a flimsy safety net," Sadoff’s company stated in its recent investment newsletter to clients. "The banks are over-concentrated in housing. They now have an immense exposure to the busted real estate bubble. Should housing prices decline, the banks could incur enormous losses."
Sadoff Investment Management has grown so wary of a housing bubble that it has sold off the four home building stocks it previously held. The company earned "phenomenal" results from those stocks over several years, but Sadoff said indicators made it believe the time was right to sell.
Home sales have been carrying the U.S. economy during the past five years, Sadoff said, and are largely responsible for lifting it from the recession. Without a robust housing market, the economy could slow drastically, he said.
However, Mark Eppli, Ph.D., professor and the Robert B. Bell Sr. Chair in Real Estate at Marquette University, is not as worried about a bursting housing bubble as Sadoff and many economists are.
The Wisconsin bubble, if it exists, could slowly leak to more sustainable prices, rather than burst altogether, Eppli said.
Although home sales are likely to taper off a bit in the next year to 18 months, they will not crash to catastrophic levels, Eppli said.
"The demand has created upward pressure, but that has started to level off," Eppli said. "As it levels off, appreciation will level off at a more stable rate."
Eppli says the parabolic curve model is flawed when it comes to the real estate market.
"The curve model presumes that the underlying value of the land will slide," he said. "That’s just not going to happen. It’s so much stickier on the downside, and there is the difficulty in bringing new lots to bear."
Eppli believes that new home construction will continue to be more difficult, and new home prices may even rise.
"Getting building permits is extraordinary, especially in some markets," he said. "I don’t think getting permits is getting easier or doing a development is getting easier. And the cost of a buildable lot is not cheaper."
Although the Federal Reserve Board has raised interest rates this year, mortgage rates remain historically favorable for homeowners, Eppli said.
Estimates put together by the Harvard (University) Joint Center for Housing Studies show that mortgage payments, as a percentage of household income, have stayed relatively flat for the past 30 years. The exception was in the late 1970s and early 80s.
On average, U.S. homeowners are paying about 22 percent of their incomes, before taxes, on mortgage costs. In 1981, homeowners were paying about 35 percent of their incomes, before taxes, on mortgage costs.
"People are not being tapped out by mortgage payments," Eppli said. "Don’t tell me they’re being tapped out. This says they could be paying a lot more. They’re near the 28- or 29-year averages."
Sadoff said increasing minority homeownership by immigrants in the United States could help prevent the number of home sales from falling, but may not be enough to prevent the bubble from bursting.
"There are 1.4 million new households per year," he said. "It’s definitely an offset. But it will only be an offset to a point."
Sadoff and Eppli agree that the rapid increase in home ownership was driven by new technology and the development of innovative mortgage products. While some of these products have helped people with less-than-perfect credit become homeowners, Sadoff said some of them pose risks in a down market.
Many homeowners in markets where housing prices has increased rapidly have used adjustable rate mortgages and interest-only mortgages, and Sadoff said those homeowners could be hurt most by a bursting bubble.
Even if the housing market just cools a bit, those homeowners could be hurt by rising interest rates, he said. If that occurs, they may have difficulty making their house payments.
"If you put 20 percent down on your home and never cashed out, you probably won’t be hurt," Sadoff said. "But if you cashed out your equity fully, the banks could come calling … Even if there are five years of adjusting up, there could be a lot of consumers out there having trouble making payments. And the banks have left themselves very exposed. It could back up into the banking system."
Sadoff said the Fed could raise rates to about 5 percent before it starts to slow the economy. If rates were raised that high, he said the economy would likely buckle because of energy costs, slowed housing sales and the higher rates.
Some people who have become over-extended and are looking to sell their homes could be further hurt economically because their homes will stay on the market longer in a down market, Sadoff said. That could make a post-bubble crash in the residential real estate market more difficult to recover from than the tech stock bubble of the 1990s, Sadoff said.
"With a house, there’s a lot more money in the sale," he said. "It’s not quickly traded away or sold. The scary thought about the housing market is that it’s not liquid."
The first indicator that the real estate bubble is bursting will be a national slowing of home sales, Sadoff said.
"The growth rate will come down, and it will take longer to sell homes," he said. "Sellers will see slightly lower prices from what they thought they would get. This could take months to years."
The second indicator will be prices starting to fall in markets that have not had bubble-like conditions, Sadoff said. He said metropolitan Milwaukee will be one of those markets.
At the same time, he’s not advising clients to act much differently.
"Do what you would do before," he said. "Don’t sell your house and move to an apartment. The economic impact of the slowdown in housing is the bigger sign to look out for. You may be better off with a smaller house and a smaller mortgage, because the slowdown could hurt your job. So many jobs have been created because of the housing market (boom), and they could easily go away."
Bubble Trouble?
Number of home sales
August 2003 August 2005 Increase
Milwaukee County 1,042 1,198 15%
Waukesha County 558 618 10.8%
Ozaukee County 130 171 31.5%
Washington County 162 204 25.9%
Racine County 248 307 23.8%
Kenosha County 276 275 -.4%
Walworth County 182 197 8.2%
Sheboygan County 126 138 9.5%
Median sales price, January 1 through June 30
2003 2004 2005
Milwaukee $118,212 $119,097 $142,152
Shorewood $281,599 $317,841 $335,295
Franklin $196,338 $210,441 $226,001
Racine $106,349 $111,145 $131,321
Germantown $216,430 $257,638 $251,596
Brookfield $287,870 $294,700 $315,109
Pleasant Prairie $214,168 $220,588 $242,278
Average days on market, Jan. 1 through June 30
2003 2004 2005
Milwaukee 92 59 59
Shorewood 50 56 90
Franklin 96 142 155
Racine 55 46 48
Germantown 62 68 70
Brookfield 86 67 104
Pleasant Prairie 155 83 124
* Source: Greater Milwaukee Association of Realtors
Dark clouds
Several Economic Factors Point to a Housing Bubble
That is Due to Deflate, if Not Burst.
• Both personal income and consumer spending dipped in August.
• Total U.S. consumer debt is at an all-time high.
• American credit card debt is at a record high, with a record 4.81 percent of credit card accounts being behind 30 days or more in the second quarter of the year.
• U.S. bankruptcy filings grew to record levels in September, as debt-laden consumers rushed to file before the Bush administration’s changes in the bankruptcy code to help credit card companies take effect Oct. 17.
• Inflation has ticked up 2.0 percent in the past 12 months.
• U.S. consumer confidence dipped to a two-year low in September.
• Consumers’ pocketbooks are lighter, as they face record gasoline prices.
• Heating bills are projected to rise 40 to 50 percent this winter.
• Interest rates are rising.
• Housing prices have soared over the past two years. Nationally, the median sales price for an existing home skyrocketed 14.1 percent between July 2004 and July 2005, even though wages have remained stagnant.
• Mortgage applications declined in July and August.
• The U.S. Housing Affordability Index is the lowest since 1991, meaning wages and home prices are out of whack.
Sources: The U.S. Department of Commerce, the National Association of Realtors, U.S. Federal Reserve Bank.
