"Five years into a housing boom that has boosted U.S. home values an average of 50% and added an estimated $5.5 trillion to the total market value of residential real estate, many Americans no longer think of their home as just a place to live. Instead, it’s a cash machine that can be used to rapidly build wealth. To that end, a growing number of people are tapping into their home equity to invest in more real estate.
That’s a lot like using a margin account — a line of credit backed by securities in an investor’s portfolio — to buy stocks. During the 1990s, many investors used such accounts to buy shares in fast-rising tech stocks. When the dot-com bubble burst, the value of the shares bought on credit cratered and investors’ borrowing worsened their losses. Economists say today’s debt-fueled investment binge in real estate is fanning the flames of an already overheated housing market, and making demand from people who actually need houses to live in seem stronger than it truly is."
That pretty much sums it up. Whether we describe it as bubble or not, the economic benefits of a rapidly rising asset class cannot go on forever; especially if its financed via debt or worse, excessive leverage.
click for larger chart
graphic courtesy of WSJ
graphic courtesy of WSJ
Oh, but there’s more:
"A riskier and more aggressive way to use home equity is to plow it into investment property, as the Epsteins did. A survey by SRI Consulting Business Intelligence, a research firm in Menlo Park, Calif., found that nearly 2.2 million households used their home equity to buy additional real estate in 2004, up from roughly one million a decade earlier. "As long as there isn’t a major change in the marketplace or a bubble burst, it will go up again," says Larry Cohen, director of the SRI division that does financial-services research and consulting.
To make the deals work, [some] turned to so-called option adjustable-rate mortgages, or option ARMs, which carry introductory interest rates of less than 2% and give borrowers multiple payment choices. Option ARMs can be particularly risky because the interest rate adjusts as often as once a month. If rates rise, borrowers who elect to make the minimum payment can see their loan balance grow, a plight known as negative amortization.
What Americans are generally not doing with their equity is letting it build, as homeowners traditionally did. The huge rise in home values translates into more equity for homeowners. But many of them have extracted those profits from their equity, and many people buying homes now borrow a larger share of the price than they did years ago. So mortgage borrowing has grown even faster than home values have. As a result, homeowners’ equity as a percentage of the market value of all homes declined to 56% at the end of 2004 from 57% five years before, according to data from the Federal Reserve."
I could excerpt nearly the entire piece — its that dead on. Rather than do that, I suggest you read it in its entirety.
As Prices Rise, Homeowners Go Deep in Debt to Buy Real Estate
Economists Say Move to Tap Equity May Inflate Bubble; Like Buying on Margin
Deal Sours for Mr. Drogsvold
James R. Hagerty And Ruth Simon
The Wall Street Journal, May 23, 2005; Page A1