Saturday, June 11, 2005

The Real Estate Bubble in Chicago

There has been a lot of talk about a "real estate bubble" with the rising home prices in the country. In this blog I try to not talk about a topic unless I have something unique to add, or you might as well just open the paper.

When we sold our condo in Bucktown, a strange thing happened. The buyer wanted to get cash back at the closing. In other words, if we agreed on price "x", the buyer wanted x + a few thousand dollars to pay their closing costs, so it essentially cost them nothing at closing. When I first heard this, I thought it was nuts, but my real estate agent said that it was pretty common. The buyer had qualified for a loan and I guess it wasn't any skin off my back, but it was definitely a sign that times were changing. One more sign of the bubble - we sold our condo in one day (at a good price, too).

From their perspective, you get cash back when you buy a car (financing it, I guess), so why not get cash back when you buy a house? That is what is happening nowadays.

Another big trend is interest-only mortages. I read that over 60% of the single family home mortgages in San Francisco CA were interest-only types. There are various articles around on this with different percentages but clearly 1) people are putting way less equity down on houses 2) these loans are far riskier than in the past.

The photo above is of the new Trump tower location in Chicago. They have a pretty cool web site once you get through the flash intro crap here.

It is amazing how many condos are being built in Chicago. These condos are not cheap - either - I heard that most of the Trump tower was already sold and people were re-selling their rights to buy condos that aren't even delivered ("flipping") for far more than they originally paid for it.

I worked with a guy from Boston who was involved with their real estate crash in the late 1980's. He had a condo and got divorced so he had to sell it. At the close, he had to bring cash because the value of the condo had declined since the initial purchase. Yikes! I think this is going to happen to a lot of other people when the crash hits...

Do I know when the bubble is going to burst? No. But things don't just go up forever, as we all saw during the dot-com boom.

Another sign of froth is the disconnect between real estate rental rates and the cost to buy. A friend of mine owns a condo in the city and a home in the suburbs and he finally gave up on renting the city condo. It is very nice on a high floor of a building but a lot of the people who used to rent are now buying, probably taking cash back on an all-interest loan (just speculating). The gap between the ability to rent and the purchase price is another key sign of a bubble. My friend furnished it himself and is going to stay on weekends over the summer and then try to rent it later.

Another thing driving up values in Chicago is the low value of the dollar vs the Euro. We get a lot of buyers from Europe here buying summer homes and speculating on real estate. I talked to a guy at the cubs game from Amsterdam and he said that prices in Europe are insane, you can't buy real estate (land) anywhere decent for under $1M, so they come here where they can find action at a lower price point. I guess we have a lot of land in the US compared to Europe and Asia where the population densities are much higher.

If the bubble does break you won't see it right away like with stock prices. If prices go down, people won't sell, especially if their home equity is negative. It probably would make sense for a lot of these people to walk away from their mortgages like occurred in Houston during their late 1980's real estate bust - just give the keys back to the banks and walk away...
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