|Do rising prices necessarily constitute a “bubble”?
For the past year or so, the financial and popular press has been publishing a flurry of articles raising the specter of a real estate bubble that may—one of these days—be about to burst. Writers love to quote the most frightening statistics and proclaim the most alarming consequences. The British magazine The Economist earlier this year went so far as to call the global housing market "the biggest bubble in history."
No doubt, the story of home prices shooting up by hundreds of thousands of dollars—accompanied by the scary thought of dropping even more quickly—makes for high drama. This may be a good way to sell newspapers and magazines, but how helpful is it to normal investors? Scare tactics seldom lead us to our best decisions. Thinking clearly and rationally about a possible real estate bubble is a much more effective approach.
The evidence of rapidly rising housing prices is hard to deny. Here in New Jersey, home prices are already up 15 percent again this year. But there's a question as to how significant these changes are in those of us who are invested for the Big Picture. In this installment of our Echelon Wealth Strategies newsletter, we'll examine how the prospect of a real estate bubble should concern long-term investors.
WHAT IS A BUBBLE?
|Prices become separated from the concept of value.
In a bubble, people chase after rising prices not because the product is worth that much, but simply because they expect the price to keep shooting euphorically upward. Eventually, when people realize they're paying more for that product than its likely long-term value, they stop buying it: the price drops, and the bubble pops. The key is that the prices become irrational.
That may not be the case with housing prices. Unlike tulip bulbs or Priceline.com stock, a house has real tangible benefits in addition to being an investment. No matter what happens to the price of your home, you will always be able to get great use out of it.
But there's a larger concern at work here. Most of us have bought our homes for the long haul. We can watch the price go up (and sometimes down) over the years, but the only day we really need to be concerned about our house's value is the day we choose to sell it. Whether real estate prices will continue to climb rapidly, slow to more normal rates of growth, or drop significantly, no one knows. The good news is, you don't need to drive yourself crazy over it. If you plan to stay in your house for more than the next two or three years, whether there's a bubble or not should be of little concern to you.
But if you've been thinking about moving, because of retirement or children going off to college or some other reason, it may be time to reconsider your timetable to take advantage of inflated prices. Changing one's overall strategy in response to temporary market conditions is rarely a good idea, but making tactical shifts like the timing of a sale can sometimes work out well. Selling your home now may lock in gains, but be sure you won't regret missing out on the next 15 percent or 20 percent upward move in prices if the market keeps climbing.
DIVERSIFY, DIVERSIFY, DIVERSIFY
|Proper asset allocation protects you for the long haul.
The people who were really burned by the last investment bubble—the dot-com collapse in 2000—were those investors who sank a disproportionate amount of their money into highflying technology stocks. In any type of market, one of the paramount virtues is to be properly diversified. The worst-case scenario, if the housing market does indeed crash, is to have the preponderance of your wealth tied up in real estate. With proper asset allocation, you can take advantage of the gains from an overheated market like the current one in real estate—and be protected against a bubble.