Double Bubble: Are Stock And Housing Markets Both Heading For Disaster?

Forgive homeowners and prospective buyers for feeling a little déjà vu about the recent run-ups in the real estate and stock markets. After all, eight or nine years …

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Forgive homeowners and prospective buyers for feeling a little déjà vu about the recent run-ups in the real estate and stock markets.

After all, eight or nine years ago, both markets were ascending into the sky only to crash and burn like the Hindenburg in a matter of months.

Lately, people have been asking — particularly here in the Denver area where home price increases have been second only to San Francisco — whether there’s a bubble in real estate prices.

As both a real estate industry CEO and a self-directed stock market investor, I get more nervous these days about my equities investments. Stock markets do have a history of regularly rising and falling by double digits, even if equities outperform real estate over the very long term.

Of course, with recent uncertainty about China’s stock market and whether Greece will leave the eurozone, volatility in stocks is likely to be par for the course. (Over the weekend, eurozone leaders reached a new rescue deal for Greece that will keep it in the currency union.)

Real estate feels more stable. Speculation is dampened by transaction costs — the 6% fee a broker takes plus closing expenses — and carrying costs: repairs, insurance and taxes. And high rents are making homeownership attractive.

The housing collapse of the late 2000s was a once-in-a-century event; a similar one last occurred in the 1930s. Low interest rates fueled the fiasco, but other factors contributed, too: lax lending standards, inept regulation and complex mortgage derivatives that concealed huge risks.

By comparison, a repeat of something close to the bear market of 2007-2009 in stocks — a 57% decline in the three major U.S. indices — seems to me to be more possible in the not-too-distant future.

Since 1929, there have been 25 declines of 20% more, the level in which a correction becomes a bear market. The average decline has been 35%. The largest drop was a little more than 80% during the Great Depression.

They also occur on average every three and a half years.

We are presently six years and three months into a bull market, the third longest in history, after a run lasting seven years and two months that ended in August 1956 and the 12-year-and-four-month marathon that ended in March 2000.

A case can be made that a modest decline in the stock market will drive cash directly into housing or into bonds, which would reduce interest rates, to the benefit of real estate buyers.

If the stock market decline is unusually steep, however, as it was in the last decade, that could depress the overall economy in ways and to a degree that housing demand drops.

The rise and fall of real estate remains largely a local process, however, tied to the vagaries of city, state and regional economies, often linked to industries such as oil, automobiles or construction.

Overbuilding, too, especially in areas with few natural or zoning barriers to expansion, such as in Las Vegas or Phoenix, can also depress local housing prices. In both of these markets, real estate prices have yet to return to their old highs.

Another local caveat is the strong dollar, which hurts the purchasing power of foreign buyers, generally on the East and West Coasts. When those buyers vanish, as they periodically do, some markets, such as Miami, suffer, sometimes in isolation from much of the rest of nation.

Homeowners and buyers often err in judgment, however, when they project short-term changes in price — high or low — into the future. They should look instead at a local market’s long-term performance, as they are making a long-term investment. A home, after all, isn’t a penny stock.

Still, the premise that a pop in one market bubble always leads to another is full of hot air.

This article was republished with permission from TheStreet.

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