Is A Real Estate Bubble Forming in South Florida?
By Roy D. Oppenheim, Esquire
Connie Lewin

For South Florida, then, the real estate market reflects both investor enthusiasm and enthusiasm for home ownership with new demands coming from the climatic and multicultural attributes of the region. There remains an unwavering demand for South Florida housing, with unprecedented growth in Palm Beach County and steady growth in both Fort Lauderdale and Miami. South Florida continues to attract new residents from Canada, the Northeastern U.S., Latin America and Europe, and that high demand is outpacing new construction, creating unbelievably a housing shortage.  Therefore, while experts are split on whether a housing bubble exists in the United States, for South Florida the soaring demand and drop in inventory suggests that home prices will continue to remain strong.

As interest and mortgages rates begin to steadily rise, economic analysts are reviving a debate of whether a bubble is looming over the real estate (or housing) market. A bubble, in real estate terms, is the point where home prices are no longer sustainable, indicating that the market is headed dramatically downward, usually at least 10 percent.i

The bubble argument rests on two main suppositions: the decline in interest rates by the Federal Reserve inflated the housing bubble, and subsequently, rising interest rates will most likely burst the bubbleii ; the other argument is that real estate speculation, driven by low mortgage rates, has created an artificial demand and home prices are thus poised for a decline.iii

Forecasting whether a bubble exists and if it does, when the bubble will burst is near impossible. Even so, the overheated South Florida real estate market is raising concerns that the market mania is reaching the unprecedented rise and subsequent precipitous decline of tech stocks at the turn of the millennium.

Demand is still at an all-time high. According to the Florida Association of Realtors, South Florida’s home prices rose strongly over a 12-month period. Home prices increased a whopping 26.8% in Fort Lauderdale from $220,000 to $279,000; 25.8% in Miami from $216,000.00 to $271,900.00 and 25.8% in Palm Beach County from $233,600.00 to $294,100.00. The figures are based on the number of second quarter median sales in the area from April 2003 to April 2004. Real estate professionals are crediting low mortgage rates to the heated rise of home prices, driving would-be buyers to deciding and biding quickly and furiously.

Real estate is also a hot market for investors as well. The downturn in stock values has prompted investors to literally bank on the robust real estate market for high returns. Both local brokers and brokers from Latin America are attracting potential investors to South Florida with preconstruction investing into condominiums with the promise of returns as high as 100% per year…sometimes more.

Indeed, many of these investors have no intention of ever living in the units they buy; instead, they look for rental income or are more likely to resell their units for a profit.iv Both the New York Times and Associated Press have noted the increasing trend in house flipping, investors solely buying homes that they can “flip” for a quick sale and a big profit.

It is these speculative buyers that analysts accuse of being culprits since they are creating an artificial demand for condominiums and homes that will quickly vanish as soon as mortgage rates and interest rates increase. Many of these buyers and investors are buying simply due to rising prices instead of for intrinsic value, such as one’s desire to use the property for oneself.

Secondly, the high price jumps of homes have risen faster than incomes. In a recently released report from HSBC, entitled The U.S. Housing Bubble — The case for a home-brewed hangover, HSBC chief U.S. economist Ian Morris found that house prices relative to income, rent, replacement-cost and home-equity is reaching record highs. Home prices, he warned, could decline by 5 percent to 10 percent nationally over the next five years. “Expectations of future house price appreciation are spectacularly, and unrealistically high,” he said.v

The decline in rent-to-price ratio also signals to some economists that a bubble is looming. Dean Baker, co-director of the Center for Economic and Policy Research, argues that if home prices are at a higher rate than rental prices and inflation, a bubble must be looming. If a growing population and a limited supply of homes are causing the increase in home prices, rental prices should also be roughly the same amount as home prices. Rental prices, however, are at a standstill and are not appreciating at the same rate as home prices.vi

Rising mortgage rates can also impact the housing market since they make homes less affordable, which can hurt selling prices. Analysts at Business Week Online found that if 30-year fixed-rate mortgages rise just one percentage point, to 7.2% from their current 6.2% -- well within the range of forecasts -- house prices would have to fall 11% to keep new buyers' monthly mortgage payments from rising. If fixed rates went to 8%, prices would need to fall 20% to keep payments level.vii Mortgage debt has also risen faster than home values since 2000, according to Federal Reserve data. Many analysts argue that it is the relationship between interest and mortgage rates that inflate and deflate the real estate bubble.

If the real estate bubble exists, experts argue, its explosion could also greatly impact the economy. Goldman Sachs economist Jan Hatzius argues that a decline in housing reduces consumer spending at least as twice as much as a same-sized loss in the stock market.viii

Optimists of the real estate market, on the other hand, downplay the danger of a bubble, by pointing to the fact that despite the increase in interest rates, mortgage rates remain at a record low and the tight supply of homes for sale has helped to boost demand. Some economists also argue that rising interest rates are an indicator of the health of our economy.

"The reason interest rates are higher is that we are in a growing economy," said NAR chief economist David Lereah in a recent release. The opinion is that rising salaries and stock market returns can create enough wealth to offset the negative effects of rising mortgage rates.ix

Optimists of the real estate market also point to the government’s campaign to boost the rate of home ownership. The government introduced initiatives to boost the rate of house ownership with tax incentives and the private sector has responded too, with increased competition in mortgage lending in the past decade.x

Economists at the Federal Reserve have also disputed the bubble theory. A recent 12-page report titled, “Are Home Prices the Next ‘Bubble’?” by Jonathan McCarthy, a senior economist, and Richard W. Peach, a vice-president, at the Federal Reserve Bank of New York, reached the conclusion that “the most widely cited evidence of a bubble is not persuasive because it fails to account for developments in the housing market over the past decade. In particular, significant declines in nominal mortgage interest rates and demographic forces have supported housing demand, home construction, and home values during this period. Taking these factors into account, we argue that market fundamentals are sufficiently strong to explain the recent path of home prices and support our view that a bubble does not exist."xi

The report attributes the rise in home prices to inflation, but more significantly to the changing demands and tastes of home buyers. In addition, mortgage rates are still at a record low. It is demand that is causing rising home rates.

According to Freddie Mac, a federal mortgage corporation, fear of a real estate bubble is unwarranted because the housing market does not exhibit the boom and bust traits of an economic bubble. Amy Crew Cutts, deputy economist at Freddie Mac, points to the fact that housing costs are high, holding time is quite long, and most people buy homes for consumption, not investment. Cutts argues that prices in the real estate market are rational since they reflect current economic conditions.xii

For South Florida, then, the real estate market reflects both investor enthusiasm and enthusiasm for home ownership with new demands coming from the climatic and multicultural attributes of the region. There remains an unwavering demand for South Florida housing, with unprecedented growth in Palm Beach County and steady growth in both Fort Lauderdale and Miami. South Florida continues to attract new residents from Canada, the Northeastern U.S., Latin America and Europe, and that high demand is outpacing new construction, creating unbelievably a housing shortage. Although there are many buyers seeking to flip homes for high returns, there are equally as many South Florida buyers looking for places to live and are taking advantage of the currently low mortgage rates.

Therefore, while experts are split on whether a housing bubble exists in the United States, for South Florida the soaring demand and drop in inventory suggests that home prices will continue to remain strong. Prices may dip or not continue their immediate escalation, one thing is certain, that long-term, real estate is still your best investment. According to the Florida Association of Realtors, the median price of a resale home in Florida has jumped more than 51% over the past five years.xiii Demand might cool with rate increases, but buyers are still willing to shell out for the high prices of homes.

Advice for new buyers is to spend only what you can afford, use home equity with care and do not plan to buy a house if you do not plan to live there for a few years. If you are a “Flipper,” be ready to close on the property and rent out the place for a few years if you are unable to sell. Otherwise, be ready to walk away from your Real Estate Deposit.

Real estate investing is really just like musical chairs; when the music stops, and it will, because it always does, will you be left standing out in the cold?

Roy D. Oppenheim, a well respected Real Estate attorney and consumer advocate, is President of Weston Title and Escrow, Inc. Mr. Oppenheim actively invests in Real Estate and represents clients concerning their Real Estate investments.

Connie Lewin is a senior at Princeton University majoring in Comparative Political Systems and is an active member of the Whig-Cliosophic Society.

Copyright Weston Title & Escrow 2004

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