The Housing Bubble: The Big Picture

Do rising prices necessarily constitute a “bubble”?

The financial and popular press has been talking with great excitement over the past year or so about the specter of a real estate bubble that may be about to burst. Everyone seems to be on the lookout for the most frightening statistics and wants to proclaim the most alarming consequences. The British magazine The Economist went so far as to call the global housing market “the biggest bubble in history.” That seems a bit extreme or at least premature. In this edition of our newsletter, we will take a look at the housing bubble through the Big Picture view of investing.

After the dot-com bubble burst in the year 2000, the stock market went through one of the worst periods in its history. Many people expect something similar to happen in the real estate market. But investing in a house is very different from stock investing. Most of us will stay in our houses for decades, getting real use out of them.

To be sure, the short-term indicators of rapidly rising housing prices are hard to deny. According to The Washington Post, the average assessment of a home in Northern Virginia has doubled in the past five years. But just because prices continue to rise doesn’t mean they will necessarily come crashing down. In the Big Picture approach, whatever happens to a home’s price in the next year is only relevant if we’re thinking about selling. Otherwise, the bubble—whether it exists or not—is not something most of us need to be concerned about.

What Makes a Bubble?

Prices become separated from the concept of value.

In an investing bubble, people chase after rising prices not because they think a product is actually 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 and separated from the concept of value, which may not be the case with housing prices.

For most of us, our home is more than an investment. It’s one of the central parts of our lives. Selling off 1,000 shares of IBM won’t have much of an effect on the rest of your life. Selling your home—or even a vacation home—will have an enormous effect on your personal life. You can’t buy and sell homes strictly on the basis of how such actions affect your portfolio.

But if you’ve been thinking about moving because of retirement or children moving out 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 you might miss out on the next 15 percent or 20 percent upward move in prices if the market keeps climbing.

Let’s think back to that dot-com bubble: Did it play havoc with your overall financial goals? Or were you properly diversified, enabling your portfolio to withstand the upheavals in one sector of the market? As long as your asset allocation is in order, even the actual popping of a bubble shouldn’t cause you too much damage.

Diversify, Diversify, Diversify

Proper asset allocation protects you for the long haul.

The people who were really burned by the dot-com bubble were those investors who sank a disproportionate amount of their money into high-flying technology stocks. In any type of market, one of the paramount investment 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.

The short answer to the prospect of a bubble is: don’t panic. Remember, you’re in this for the long haul. And over that long haul, real estate prices tend to go up—historically not quite as much as the overall stock market but up nevertheless. You can’t say that about priceline.com.

That’s our philosophy at Bernhardt Wealth Management. To hear more about how we see the Big Picture, give me a call at (703) 356-4380 or e-mail me directly at Gordon@BernhardtWealth.com. Or visit our Web site at www.BernhardtWealth.com.

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