Over at thestreet.com, great technician Dan Fitzpatrick weighs in on his thoughts about the real estate bubble and shows why he should stick to analyzing charts. While I’m as tired as everyone of hearing about the real estate bubble (hedge fund managers whom I talk with have been discussing it since 2002 now), I think investors need to continue to monitor it. Here’s Dan’s argument as to why he’s tired of the bubble talk –
The affordability issue acts as a natural regulator on the real estate market. When folks can’t afford to buy a more expensive house, they just won’t buy one. Period. But a dropoff in new purchases doesn’t necessarily translate to a popping of a bubble.
Will most folks just decide to sell their homes and move into apartments? I know one guy who did that three years ago, assuming that he’d be able to buy a nice house for cash once the real estate bubble burst. He’s still renting.
It will always be extremely easy for anyone to buy into a stock-market bubble. If a high-flying stock is too expensive, you can just buy fewer shares in the same company, or wait for it to split its stock. The same cannot be said for real estate: one product, one price, one buyer. There is no such thing as a stock split to make property easier to buy
While on the surface this is a logical argument, it ignores the fact that the current real estate bubble is being built on aggressive and unsustainable lending practices. The "new affordability" of real estate loans is encouraging people to take on much more risk than they would normally be comfortable taking on. And the increasing popularity of interest only mortgages, which were unheard of just a few years ago, has artificially spurred demand for real estate to unsustainable levels.
In addition, weak underwriting practices, lead by alternative lenders such as the home builders themselves, are giving people the opportunity to buy three, four even five homes for speculative purposes. No bank in the world would allow an inexperienced individual to take on this much risk but because lending is no longer monopolized by banks and thrifts, it has allowed the bubble to continue expanding unchecked.
And Dan is correct in saying that owning real estate isn’t like owning stock. It’s worse. Its like owning stock on a 5 – 10% margin. Even at the height of the NASDAQ bubble, you still needed 50% margin to buy a stock. But I’ve been offered real estate loans for only 3% down. That’s as bad as a commodity futures contract. If you’re wrong, you can lose much more than you put up in capital. And that’s why the real estate bubble is worth keeping an eye on. When it pops, it will have a dramatic effect on the rest of the economy, including the stock market.