Editor’s note: The Washington, D.C.-based Center for Economic and Policy Research is sponsoring an essay contest on “Why there is no housing bubble.” The winner will win $1,000. Send a copy of your entry to email@example.com, and we will publish a selection of the entries on Inman News.
Here is one entry:
There’s an underlying tension in the air and isn’t because of Department of Homeland Security’s increase in its alert color from Yellow to Orange.
There’s a frenzy that’s feeding the real estate market and that has a lot of people talking and speculating. Sorry to say this “bubble” is very real, but no matter how loud educated policy pontificators say it, this “bubble” won’t POP!
What is feeding this frenzy in real estate? Two major trends have given fuel to the fire that won’t die down anytime soon.
On a beautiful Sunday afternoon in Los Angeles right after New Year’s with temperatures hitting 80 degrees, many people’s choice of a drive with the convertible top down is to view Open Houses, not cruise Pacific Coast Highway.
One of the economic demands putting continued pressure on real estate prices is the unavoidable rise in rents. While prices have soared for single-family residences, the same can be said for income property, fueled in part by homeowners’ desire to put their equity from their personal residences into income-producing real estate. The rent for an average one-bedroom apartment in most urban centers in the United States now exceeds $1,000 per month, plus utilities paid by a renter with after-tax dollars.
When a renter realizes the average payment on a 30-year mortgage on a $250,000 home is less than the rent he or she has been paying, it’s not hard to do the math and start looking to buy.
In 2003, some Fannie Mae and Freddie Mac loan programs required only a 3 down payment on owner-occupied homes. And rents keep going up. In some areas, these same economic forecasters have seen vacancies increase as landlords try to increase rents after making improvements or selling the property to a new owner who is trying to cover the monthly expenses and generation a positive cash flow on the investment. That’s creating demand in the first-time home buyer marketplace and new home starts as well as trade-up demand.
The second reason this frenzy isn’t a “bubble” is that the current real estate runup in prices began May 7, 1997, the day President Bill Clinton signed the bill that gave mortgage appreciation relief to millions (okay, hundreds of thousands) of American taxpayers. Previously, sellers had to roll taxable profit on the sale of their personal residence into a new home purchase of greater value than the sale price of the home sold. The amount of the tax-free income generated by the 1997 law is astounding–$500,000 for married couples and $250,000 for single taxpayers.
Even more incredible when one peels back the layers of the real estate onion is the fact that homeowners can take advantage of this tax windfall every two years. Suddenly, everybody and their brother is buying real estate to rehab and flip. Yes, they’re suffering through living with the renovations, but many have switched their profession and become part-time mini developers.
So on this beautiful Sunday in Los Angeles, more than 150 shiny new cars park precariously on a hillside for a peek at a new listing that needs some TLC. And the math is simple: Can you put down 20 percent on a $1.2 million home (that used to be worth $650,000), invest $150,000, then sell it for $1.9 million?
Subtract the real estate commission of 2.5 percent since one of the homeowners now has a real estate license to take advantage of the seller-side commission, and it’s a no-brainer profit of $352,525, plus the tax deduction for home mortgage interest while you’re living there.
This gold rush of real estate is a gift from the government that is bigger than any of President George W. Bush’s tax relief programs and not a word has been heard about pulling the plug on this program that probably is benefiting upper-middle class taxpayers more than people lower on the taxpaying food chain.
Let the economists who predict there is no housing bubble shout it from the highest rooftops in the land. This is one time they may be right. As for me, I took my $500,000 (twice now since May 1997) and am sitting on the sidelines waiting for it to POP!
Julie Brosterman is an independent consultant to the real estate, mortgage and servicing industry.
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