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Bubble trouble? Unlikely

By FREDERICK R. STROBEL
Published July 10, 2005

In May, U.S. housing prices set yet another record, with the median home selling for $207,000, a 12.5 percent increase over a year ago. But Florida had that beat by a long shot, with the statewide median rising to $230,800, a 27 percent increase.

It gets even better if you're a coastal-area property owner. Consider the following median home prices and their one-year percentage increase as of May:

* Fort Myers-Cape Coral: $273,500, up 40 percent

* Melbourne-Titusville-Palm Bay: $222,100, up 38 percent

* Fort Lauderdale: $367,000, up 34 percent

* Naples: $488,900, up 34 percent

* Sarasota-Bradenton: $316,600, up 31 percent

* Tampa-St. Petersburg-Clearwater: $196,199, up 27 percent.

So the question that everyone, including Alan Greenspan, is asking, is: Is a this a bubble? And if so, when is it going to pop?

The best way to answer this question is to look at the many national developments in the past 10 years that have favored residential real estate investment in general, and Florida real estate in particular. These have increased demand for housing at a much faster pace than the supply can keep up with.

The national developments include an increasingly favorable treatment of residential property. The federal income tax cuts enacted in 2002 and 2003 clearly favored upper-income earners. These families found themselves with a substantially higher monthly cash flow, and investing in property was a logical decision for them, particularly given the lackluster performance of U.S. stock markets in those years.

Several other changes in the tax code have favored real estate investment. For example, if you own a rental residential property, you can now exercise a 1031 exchange. (That's the number of the IRS regulation.) This allows you to sell the property - and, provided you put the proceeds into a new investment property within 180 days, you may defer the 15 percent long-term capital gains tax on its appreciation. This has greatly increased the demand for investment properties - i.e. buy, fix up, rent and sell, buy, fix up, etc. - now being sought by many homeowners. Further, that long-term capital gains tax rate of 15 percent is down from a maximum of 28 percent nine years ago.

Another tax advantage is the capital gains exclusion, greatly broadened in 1997, on the sale of your principal home. A married couple can now exclude from taxes up to a $500,000 gain if they have lived in the home for at least two years. They can then buy another principal home, and do the same - that is, exclude any gains - two years later. And they can do this buy-and-sell operation as many times as they want.

Other macroeconomic factors have served to keep the demand for homes high.

First, the continued presence of low interest rates translates into low mortgage rates for homes. Today, the typical interest rates (about 5 1/4 percent on a 15-year mortgage and 5 3/4 percent on a 30-year mortgage) are at 40-year lows.

Second, the price of the dollar is cheap, giving Europeans a bargain in American real estate. They now receive about $1.20 for each euro, 50 percent more than three years ago. Florida properties are particularly affected by the weak dollar (or strong euro). Europeans, especially the Germans and the English, are major buyers of Florida property.

Then there are historically high oil prices, approaching $60 per barrel. Such prices tend to raise all commodity prices, as they did in the oil crises of 1973-74 and 1979-81. Land as a commodity tends to follow such spirals.

A final national factor is the increased popularity of Real Estate Investment Trusts (REITs), which have quadrupled in size in the last 10 years, now pouring $300-billion into real estate. The average investor can now buy shares in these companies, which lend money for real estate or buy it, again pushing up housing prices.

All of these national developments obviously increase Florida property values. But Florida property values are additionally favored by the special demand for coastal property and the boom in the second-home market.

Finally, Florida has long been a retirement and winter vacation haven, but the state has particularly benefited from the advent of the retiring baby boomers. With the third-fastest population growth rate in the nation, Florida will reach a total 30.5-million people by 2030, double the number in 2003. This obviously creates a demand for homes for these retirees, but another factor is at play: Retirees are visited by their children, who like being in Florida and being close to Mom and Dad. Those children eventually are more inclined to buy a second home here rather than somewhere else. This secondary demand related to the baby boomers is something economists had not generally anticipated.

So, is the real estate boom a bubble?

It would be if all these factors suddenly went away. Higher interest rates, should they occur, would certainly slow down housing price increases but would do so everywhere in the United States. However, the odds are that the tax advantages now given to housing are permanent. Florida's attraction as a retirement, vacation and second-home destination will remain. Coastal property will continue to be in demand.

The more likely scenario is for a slowdown in the growth of real estate prices. No bubble!

Frederick R. Strobel is Selby professor of economics at New College of Florida.

[Last modified July 8, 2005, 17:47:02]