There are two schools of thought on last year's 12.02 percent rise in home prices: Either it means the market is healthy and mortgage rates are low enough that homes remain in high demand, or it means home prices are inflated and buyers cannot continue to support such increases.
The uncertainty of whether a housing bubble even exists leaves many entrepreneurs hanging in the balance while they wait to see how changes in the real estate market might affect the economy and their businesses. To help sort out the dilemma are Bill Fleckenstein, president of Fleckenstein Capital in Issaquah, Washington, and author of the "Market Rap" column at www.fleckensteincapital.com, and James F. Smith, chief economist with Parsec Financial and a University of North Carolina, Chapel Hill, finance professor.
Entrepreneur: What do you think of the current housing bubble, and what are its implications?
James F. Smith: If [you think] it means prices rising at an unsustainable rate, then true, prices will not continue to grow at double-digit rates, but they will continue to rise. If you think it means the demand for houses will collapse, you're absolutely crazy. There is no housing bubble.
Bill Fleckenstein: Inflated housing prices are not what created the real estate bubble. It was lending standards that allowed people to finance homes they could not afford. Never before have lending standards dropped so low to allow no down payment and 100 percent financing. In addition, the serial extraction of equity via home equity loans has allowed people to live beyond their means. It's the financing mania that will cause grief [to entrepreneurs]. That is what has made this cycle so dangerous.
Entrepreneur: Will the market soften?
Smith: The national average home ownership rate was 68.8 percent as of third quarter 2005. Homeownership rises steadily-past 83 percent-until the age of 75, and 77 million baby boomers are just approaching age 60, so [the market impact] hasn't peaked.
Fleckenstein: There will be a nasty fall in the real estate market. If the average consumer is tapped out, then my contention is they are going to cut back on their spending, and most businesses will be nega-tively affected. That is going to [cause] a recession.
Entrepreneur: What do you think entrepreneurs should be doing now?
Smith: If you want to be in a business that's likely to be very good for a very long time, then do anything you can think of related to housing. There is plenty of opportunity. Remember, in Florida they are still trying to rebuild everything that was destroyed from Hurricane Ivan, so I imagine that Wilma, Katrina and Rita will generate lots of income for some time to come.
Fleckenstein: What entrepreneurs need to understand is that people who were using their homes as ATMs will no longer be able to do so. When our real estate bubble bursts, we'll be left with a financial system riddled with bad loans and consumers who owe more on their homes than they're worth. This will not be good for business, and entrepreneurs need to figure out what that means to them and the industries they're in.