The American Spectator

Special Report

Are We in a Real Estate Bubble?

By Barron Thomas on 7.6.05 @ 12:07AM

Conversations at trendy dinner parties in New York, Los Angeles, Scottsdale or Aspen can be very enlightening. Due to today's obsession with being thin, you won't eat a lot at these gatherings, but you will learn a lot.

Around 1998-1999, dinner party talk in L.A. and most cities was centered around the lucky ones who had just made a killing by selling their company for a huge price, all-cash, to something like dogwithfleas.com, or terrible-idea.com, or totallyhotair.com, or other similar concepts that are now on the junk pile of American financial history. By the summer of 2000, the talk was shifting to "How high will the market go? Should I get a second mortgage and buy more? When will the Dow hit 36,000?"

Talented people with serious jobs were soon staying home all day in their bathrobes and making a million a year doing day trading. Buy, buy, buy and you would get rich, rich, rich. And it worked. For a while. But, by the 2000 year-end Christmas parties, the hot topic of conversation was becoming, "Do you think maybe we're in a tech bubble?"

A very wise old Greek philosopher, or a Madison Avenue ad executive, or maybe just a really rich, smart old guy in Miami Beach once said, "Those who do not learn the lessons of history are doomed to repeat them." Now, the dinner party talk in Los Angeles and across a lot of America, for last few years has been about gleefully swapping stories about how much each person has made from "flipping." At a recent very elegant sit-down dinner in the Hollywood Hills, everyone at the table had at least four houses; one house that was their primary residence, and the others they had bought "on spec." Some owned even more. And those were the Doctors, dentists, and lawyers. You were considered a total slacker if you didn't have at least five escrows in process, either buying or selling. These spec houses were undergoing major facelifts or makeovers, at the direction of these dentists, doctors, and lawyers. And these people were now spending less and less time at their day jobs, and more and more time scouting neighborhoods for opportunities of quick riches.

But that was last summer. By Thanksgiving, 2004, the same people were asking me casually, "Do you think we're near the top?" And by this Memorial Day, 2005, they were now asking, in a more somber tone, "Are we in a Real Estate Bubble?"

It's like the very sad and forlorn lover who asks you "Do you think my girlfriend is cheating on me?"

If you have to ask...

The answer is yes.

PERSONALLY, I DO NOT CARE one-way or the other, but as one who earns a living in real estate, I need to know.

As a buyer and seller of real estate, you can make money for your clients, and yourself, if you know the answer.

My conclusion is not from deep, inner meditation, or from staring into my secret Real Estate Crystal Ball. It is from thoughtful observation of what is actually going on right now. You can draw your own conclusion, but here's eight reasons why I am very concerned:

1. Everyone is doing it. When a lot of amateurs, with no particular expertise, are blindly putting every cent they have into something, that is the time not to put money into whatever they are doing. People who don't know a two-by-four (a piece of lumber) from a granite counter top are borrowing and erecting $2 million dollar spec houses. Centex, Meritage, KB Homes, Del Webb, and Lennar totally understand designing and building spec homes. Does the anesthesiologist from Orange County? Or the takeover lawyer from San Jose? My very capable cab driver in Manhattan, the friendly Hertz bus driver at LAX, my wonderful FedEx lady, the waiters where I go to lunch, and even the bartenders, and my barber are all eagerly buying and selling and speculating in real estate after reading a few books and buying some tapes off late-night TV infomercials. One of these young people bought a nice but unremarkable lot near her home about a year ago. She just received an offer that makes her a $250,000 profit on the lot, or about five times her annual salary. She asked my opinion. (Note: there are six other lots for sale on the same nice but unremarkable street, and all are held by speculators). I unofficially suggested she take the offer. She declined it because she thinks the prices will keep going up.

2. Prices setting Record Highs: Rupert Murdoch's recent purchase of his very cool digs at Fifth Avenue and 64th Street just set a new record for an apartment sale in New York City ($44 million). I guess it has a pretty good view. Just before that, the Ralph Lauren/Polo Shop Building in Manhattan, that makes you feel wonderful just to walk through it, sold for a staggering $2,700-plus per square foot. That's a lot of $800 sweaters and $200 T-shirts. Not to be outdone, my favorite, the PanAm Building (now called the Met Life Building), just set a new world's record for an office-building sale ($1.79 billion, yes, that's with a b). Granted, the economy is decent, but is it really good enough to justify these prices?

3. Sudden, Very Rapid price appreciation: For years, prices rose mostly on supply and demand. More people on the planet needing a place to live, or companies were selling more widgets and needed more factory space to build those widgets; but lately, prices are rising much faster than the net consumer population growth -- the index of inflation or the GNP. In many popular cities, property has appreciated 100% since 1995. These same cities have not had a 100% increase in population necessarily over the same time period. In really hot, select neighborhoods in Miami, Scottsdale, Las Vegas, Los Angeles, and New York, prices have appreciated 100% in the last five years, but the population growth and income growth have lagged considerably behind that. An apartment building near Palm Springs that sold last year, at almost full price, has gone back on the market 30% above what I sold it for 14 months ago.

4. Brokers saying, "Prices will only go up": I have practiced in the mirror trying to say this sentence without laughing, and I just can't pull it off. This statement is mathematically ridiculous and mathematically impossible. Prices are determined by what a person will pay, and for most buyers, that is determined by what they can get a mortgage for, and in most cases, that is totally determined by their income. Incomes have not risen, by and large, 100% in the past five years. So why would prices move independently of earning power and population growth? Historically, prices have gone down several times during the present lifetime of today's prolific baby-boomers. Unfounded in fact, wildly optimistic claims are generally only made in hyper-inflated markets.

Letter to the Editor

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