Rising Cost of Real Estate

¶ … prices of real estate are on their way up and thus it would be a prudent investment for a person. The reasons for this are a continuous hike in prices, and there are clearly two main reasons for the increase in prices -- the decrease in interest rates that have occurred in spite of steps by the government to the contrary and the speculative activity that is taking place in real estate. It would be noticed that people are moving out of the decisions of the government regarding interest rates, and interest rates are likely to remain low for some time which would make an investment in real estate a prudent investment. Regarding the speculative part of the investment, it is likely that even in spite of the increase in prices, the returns from real estate is still low as compared to other investments and the yield is likely to be maintained. However as is the case for any speculative investment, this cannot be a long-term strategy. Some of the fall out effects of this price rise are also worthy of note.

The Rising Cost of Real Estate

Introduction

The rises and decreases in price of any product is a method for individuals to gain money and there are no moralities to the issue. On the subject of real estate, one must understand that the price of real estate varies from area to area, but there is a general trend in the market. In the case of Washington DC it has been seen from February that the prices of very similar houses have been going up steadily and even though the houses were being sold only a few months apart from each other, the prices of the latest was about $15,000 more than the previous house of the same type. Taking the case of a four-bedroom colonial house, one buyer had to spend $30,000 more than the previous sellers had asked for a similar house just 20 days before. The house had even started off a bidding war and the buyers had to pay $26,000 more than the asking price to get the house. (Deane, 2005)

Discussion

It is not that prices are going up without a reason -- one of the main tasks of the real estate agents is now to protect the homes from misuse. This has led to an action in Massachusetts against the common cold drug called Sudafed. There is a proposal to put the nasal decongestant out of the free drug store sales and lock it up behind pharmacy counters. There is no specific grudge against the medicine for cold, but the product is a main agent for the illegal manufacture of a drug that takes teens into its grip and wreck happy homes. The dealers for drugs buy up on Sudafed to convert it into crystal methamphetamine, which is also called "crystal meth." At the same time when this conversion is done illegally, the entire home is filled up with noxious fumes to make the house inhabitable due to the deficiencies of the illegal home lab. (Voorhis, 2005)

Earlier the craze for this meth drug was only in Oklahoma, Iowa and Texas, but the craze is now moving east. This has led to proposals for legislation to make the base material, Sudafed tablets under lock and key in the pharmacy stores. There will be no restrictions on the liquid form of the drug as it cannot be used for such purposes, apparently. When the new law is passed, the intending customers would have to request for the drug, sign for it and show identification to prove that they require the drug. The purchase limits will also be fixed to three packages a month. The restrictions might seem severe, but there are also other states which are proposing similar laws. The entire efforts are being taken up by the real estate agents to keep the properties as habitable and this is certainly a worthwhile effort. (Voorhis, 2005)

At the same time, one has to understand that the prices are rising fast. According to the picture that is seen, there are very few houses for sale and this is leading to the increase of prices at a very rapid rate and that in turn is leading the buyers into a bidding spree against each other. This is the general scene during this time of the year and is happening from year to year. For the Washington area, there have not been any calculations as to how much the prices have increased, but the estimate of the local agents for real estate say that there has probably an increase of 15% since the beginning of the year. The calculated figures for the increase last year are available and then the increase was 21%. The calculations for last year are calculated by the Office of Federal Housing Enterprise Oversight, and that is an organization of the federal government to track housing prices. The same agency states that the prices have increased by 89% over the last five years. For the people who own these homes, it meant a fast increase in wealth though it may not have been realizable. At the same time it has led to the stretching of budgets for those who were planning to buy homes, and also the first time buyers were getting stuck in homes which they had bought the first time. This is also leading to a shortage of homes as they are not able to trade in their homes for bigger, better houses. According to some, this is leading to a bubble and that will lead to a gap between rental costs and ownership costs. The reason for this is that there are a large number of investors buying rather than occupants buying. That means that the boom has been sustained through the low interest rates and that kept monthly payments down even with increases in purchase prices. (Deane, 2005)

It is clear now that there is an increase in housing prices that is taking place, and two reasons have been offered for the same -- as a compensation for the housing agents who are doing a service, and the second as a result of low interest rates. When one looks at the total picture, then one will see that the increase has taken place not only for the last two years, but has been happening since late 1990s. Another theory has been that the increase in prices have taken place is due to the shortage of land, and this is causing the increase in prices of houses. This cannot happen all of a sudden as the growth in population is a slow process and the shortage of land, even if it has occurred has not taken place all of a sudden, but had to be a slow and gradual process. (Shiller, 2005)

The other logic that is given is that items required for the building of houses -- labor, lumber, concrete, steel, etc. -- all have been in very heavy demand and this has led to the rise in prices. Yet, the increase in prices of these items has only followed the long-term trends of growth for prices of every commodity in the world. This brings us back to the argument that the increase in prices is due to the cuts in interest rate that have been implemented in many countries, and the U.S.A. To take care of the weaknesses of the global economy. This has certainly contributed to the increase in growth, but the interesting feature is that the regular and concerted boom that is being experienced now is not likely to be only due to this reason. We have already seen that there is no way of explaining the rise due to increases in population or building costs. The increase in housing prices have increased very sharply from 1998 and this is happening not only in USA but in many other cities of the world. (Shiller, 2005)

The increase in housing prices in California has hit the education scene in Bay Area, and while the owners of the houses are seeing that their investments are yielding very good results, the effects on the education scene is harmful. The increase in cost has made it impossible for young couples with small children to move into the city area. This is resulting in a massive drop of enrolment in that area and the schools are getting hurt. One of the school teachers has tried to analyze the situation and he has found some cause and effect. The pattern earlier was that families with small children moved into the area, raised their children and then moved out after recovering their investment through sales to a new family. Now all the families with small children seem to find it very difficult to come into the area and in spite of the drops in birth rate, the schools in the outskirts seem to have an increase in enrolment. (Nevius, 2005)

In 1960, it was recorded that 24.5% of the residents in San Francisco were below the age of 18 and today that percentage has dropped to 14.5. This figure is the lowest among all major American cities as information from Population Connection which is a non-profit organization. Now when some units are sold for lower income persons there is a massive demand. Five houses were fixed for persons below a level of $70, 000 a year in a project having 47 houses. The result is obvious from the project manager for the city who says that over 500 people have picked up forms to apply. (Nevius, 2005) It is clear that this sort of demand shows that people are not being able to buy what they want, and emphasizes the existing demand.

At the same time, let us look at the views of Alan Greenspan regarding the situation of the economy. According to him, the household savings rate in USA is negligible, and it is clear to him that enough efforts are not being made by the population to accommodate the shift of the baby boom generation soon into retirement which is going to happen shortly. At least the process will start. There has been an increase in the price of imports in the meantime, and the stage that the country is in is only the beginning of the efforts to stabilize the deficits that exist in current account. Even now the deficit is more than 6% of the gross domestic product of USA. The major change of the economy has come from the increases in price of oil, and that is continuing even today. The result has been a decrease in the purchasing power of USA. The rise has been from the level of 1.4% of nominal GDP during the first quarter of 2004 to 1.8% of GDP during the current year. (Greenspan, 2005)

To a large extent these rapid changes of prices of oil that have occurred in the past have led to deceleration and acceleration of the entire economy of USA. At the same time there were surprises last year due to the decrease of long-term interest rates on U.S. Treasury securities though the federal funds rates were increased by 2 percentage points. This sort of an incident has not happened in recent history. The result is a decrease of the yield on ten-year Treasury notes by about 80 basis points when compared to last year and the yield is currently about 4%. This makes it clear that the low interest on ten-year Treasury notes and corresponding decrease in interest on home mortgages have been a major reason for the recent increase in home building and home turnover as also the increase in home prices. (Greenspan, 2005) Thus it is certainly clear that there is a good chance that home prices have increased due to decreases in interest rates and the decrease has not been at the decision of the government of USA. Thus an investment in this area should be a wise decision and should be considered by all intelligent investors.

At the same time, one has to look at another reason why it would be intelligent to invest in housing. There is a feeling now that speculation based on homes is now very much in practice. Before 1960 people of the country did not believe so much in capitalism, and this made them not depend on their property for their well being. The situation has changed today, and the general public is now better informed about prices, and this has led people to concentrate about home prices and this is leading to a reaction that such feedback ensures. Thus there have been incidents from 2000 about aggressive bidding for the purchase of houses, and thus prices have left them often in a condition where they found it difficult to pay for them. There have also been fears by the general public that the prices of houses would soon reach a level beyond their means and this has led to even more aggression in bidding. After adjusting for inflation, the prices of houses in entire United States have increased by 52% during the period from 1997 to 2004. From 1998 the increase in home prices have been more than the increase in incomes and this makes one wonder about the stability of these prices that have been reached. (Shiller, 2005)

At the same time one has to understand that the investment in houses is essentially local in nature, and this is even truer for residences. When homeowners try to get capital gains on their residence, then they have to move as that is a condition for the speculative market. There is another major difficulty in speculation on residential houses and that is the purchase and sale of these involve a sizeable commission to be paid out -- in the order of ten percent of the sales price. (Greenspan, 2005)

At the same time, one has seen that existing, residential homes have changed hands rapidly during the last few years. This increase in purchases may be reflecting the purchase of second houses by people with the objective of investment or vacations. The purchase and sales of second homes can be accomplished by families much easier as they are not their primary residences. This only means that there may be a lot of speculation that is going on in houses, and this is probably the reason for the rapid increase in prices that is being seen. This also means that one cannot rule out certain declines in prices, but even if they happened, there would not be any effects on the general economy. There is now a system of nationwide and widespread securitization of mortgages, and that means the financial corrections due to drop in house prices would not cause any problems to the economy. At the same time, for a large number of bankruptcies to take place, there would have to be large reduction in house prices as most of the house owners have already built up a lot of equity in their homes. This is true though there are a lot of persons who have taken loans to buy their houses. (Greenspan, 2005)

The impact of increasing costs has been sharp and from 1985 to 2002, the median price of houses rose from 4.9 years of income for owners to 7.7 years now. This is in eight states where most sales are made and which have 25% of the country's population. Yet, there is no stress on the buyer and the family for paying mortgage charges. This boom had not occurred in the Roaring Twenties when the Stock market was rising very fast, and though they did not increase, they also did not fall with the Stock market crash of 1929. The time when there was a real boom was after World War II and could be seen at least in the big cities. There had not been many new homes built during the War as the government restricted supply of materials, and at that time many soldiers were returning and they wanted to start families. This is the reason which worries many as the market volatility had only flared up earlier from time to time, and these had been the patterns in both the Stock Market and for housing. There have been increases in housing prices in general and from 1890 to 2004 there have been an increase of 66% in real terms which means that inflation and other effects have been removed. This is a figure that some researchers have put together. (Shiller, 2005)