Bubble or no bubble? The experts can't agree.
"I don't use the word 'bubble' because I don't think there is one," said Raphael Bostic, an economist and director of USC's master of real-estate development program. "Bubble is a word that you use to characterize markets that are irrational, that don't have underlying economic fundamentals to explain what's going on. I don't think that's what's really going on in today's housing market."
Esmael Adibi, also an economist and director of Chapman University's A. Gary Anderson Center for Economic Research, has the opposite viewpoint. "Is there a housing bubble? Yes, I believe there is," he said. The difference is based primarily on the different factors each economist focused on in assessing the market.
Bostic looked at supply and demand. He cited Southern California's attractive climate and lifestyle as well as its strong job growth and productivity - among the strongest in the nation - and sees little change in those strengths.
At the same time, he said, the supply of new homes in Southern California is getting further and further behind the demand for them - falling behind, by his estimates, by as many as 25,000 units a year in each of the past seven years in Los Angeles County alone. That has created a scarcity that has put additional pressure on prices, he said.
Based on those factors, Bostic said, it is hard to make a case that we should expect a sudden decline in home prices – barring some major, unforeseen event like a sudden slowdown in job growth or an earthquake.
He pointed to the recent slowing in the rate of housing price increases as proof the market is adjusting to conditions without a major decline in prices.
"What we're seeing is a rational market, so I don't use the word 'bubble,' " he said.
Adibi acknowledged the supply-and-demand argument, but said it doesn't tell the whole story. For example, he noted that the Bay Area lost 250,000 jobs during the last recession, but its housing prices boomed. His concern about a bubble, he said, stems from three other factors - the popularity of adjustable-rate mortgages, the large number of real-estate investors and second-home buyers, and the problem of affordability.
Almost 75 percent of the loans issued in Orange County are adjustables, many with options that allow borrowers to pay interest only or minimal amounts of principle, he said. Some of these loans are already being hit with adjustments, and he expects others will go up once the Federal Reserve ends its short-term rate increases and long-term rates go higher.
Adibi also worried about the number of people investing in homes or buying second homes, which has more than doubled from a more typical 6 percent of buyers to the recent 15 percent. These people are the most likely to bail out quickly if they see softness in the market, he said. "If a whole bunch of people think this is what they should do, you are going to see a lot of resale housing," he said. "If the resale market gets quite a bit of listings, we're going to have a serious problem that would bring bigger downward pressure on prices."
Of even more concern is affordability, he said. Because income increases have lagged far behind home price increases, only 11 percent of Orange County households can afford to buy the median-priced home, he said. He pointed to the use of creative financing and adjustable-rate mortgages as evidence that buyers are straining their finances. "People are squeezing themselves into homes that they cannot afford," he said.
Adibi acknowledged that Chapman's forecasts of housing price increases have been way off over the past three years. He blamed that on the unexpected drop in mortgage rates, which Chapman thought would increase, and on market psychology, which has seen a veritable stampede into housing similar to the boom in the stock market in the late 1990s.
But he thinks those two factors are about to change and that home prices could drop slightly next year. That, he said, would be a good thing. "The best scenario is for home prices actually to go down 3 percent, 4 percent, 5 percent and just stay there for a while for incomes to catch up," he said. "That's the best scenario that I'm wishing for the economy because otherwise it's going to be devastating."
Although the two economists differed over whether there is bubble, they agreed homeowners shouldn't sell now just because of concerns over the current market.
"Unless you are planning to leave the area, you are going to have to buy back into this market or buy something at a comparable price level," Bostic said.
"So if you are happy with where you live, then just stay there."