Originally posted by Bags:
My question on the bubble bursting in DC is that, for quite some time, DC was undervalued via real estate compared to comparable cities (though Chicago was as well, and I believe still is compared to DC's real estate growth). I certainly believe there will be a slowdown or stagnation for a while, but I'm not so sure there will be a burst here in DC with a very steady employment scene and prices that now are comparable to L.A., still far under N.Y.C., etc. [PS, no, I'm not saying DC is comparable to NYC as a city…]
The problem with that argument is that it assumes that prices should fundamentally be equal across cities. That's not the case.
The dangers to the real estate market are more related to the fact that prices seem detached from the fundamentals. That is, unless rents rise sharply or if the outsized capital appreciation continues, it is unlikely that one would make one's money back on a home purchased today.
Moreover, people are leveraged out the wazoo. The Wall Street Journal had an article a few weeks back noting that many people, in the wake of the dot-com bubble bursting, have shifted their savings from the stock market to real estate. Not coincidentally, it's many of the same people who lost money in stocks who are now making speculative real estate investments. Furthermore, people have been taking loads of equity out of their homes (in 2004, U.S. households borrowed $820bn in the mortgage market but only bought $540bn in homes). About a third of new mortgages (including refis) are short-term or interest-only packages.
Hence, the concern is that as rates rise and the economy cools off, people will be squeezed – they don't have any savings to protect them – and they will be forced to sell their homes to pay off their debts; and they will be selling into a poor market, since higher rates will dampen demand, and they will have to lower the price to attract buyers, yadda yadda yadda…setting off a deflationary debt liquidation cycle (in a worst case scenario) or simply meaning that prices will plateau (best case scenario).
There is little reason to believe a scenario in which real estate will continue to appreciate, since there is little room left for leverage and since the pool of renters continues to get smaller.