Real estate bubble? Hogwash

The recent surge in U.S. home prices has market watchers and money managers already playing defense to deter the notion that the market is entering another bubble.

“I don’t think we’d use the term “bubble,’ even though prices have been trending higher, with nice year-over-year gains,” said Joel Huffman, senior vice president and portfolio manager at U.S. Bank Wealth Management.

“Housing affordability is near an all-time high, and the very low level of interest rates has had a positive impact on the housing market,” he said. “But in terms of home prices, we haven’t gotten near where we were during the market’s peak of a few years ago.”

Prices in the U.S. housing market, as measured by the Standard & Poor’s Case-Shiller Index, rose by 10.9% over the 12-month period through March, representing the largest annual gain in seven years.

‘INCREDIBLY AFFORDABLE’

But even with such a strong rebound, home prices are still 28% below the peak levels of 2006, according to last Tuesday’s report.

“You’ve still got decreased supply and increasing demand, and the values are still incredibly affordable by historic standards,” said Brad McMillan, chief investment officer at Commonwealth Financial Network.

“We’re probably in the third inning of this recovery, but there’s no reason to believe we’re in a bubble right now,” he said. “When you really start to see a bubble, you’ll see people putting their homes on the market, and construction supply will be increasing.”

Kevin Mahn, president and chief investment officer of Hennion & Walsh Asset Management Inc., studies sales, pending sales and inventory levels to get a fix on the industry. And right now, he sees an extremely promising near-term housing market.

“Every state in the country is expected to see home price increases over next 12 months, according to the 2012 Realtors Confidence Index Survey,” Mr. Mahn, said, adding that in 2011, the housing inventory backlog was nearly eight months.

Now it is down to 4.9 months, he said.

Mr. Mahn acknowledges that the recovery has been robust, but he isn’t ready to forecast a near-term top for home prices.

“That backlog of inventory is still working its way through the system, and then we’ll start to see even more price increases,” he said. “There is also the belief that a lot of the home purchases we saw, at least last year, were driven by government incentive programs, and there were also a lot of bargain hunters out there creating activity.”

In his most aggressive portfolios, Mr. Mahn has up to 15% allocated to real estate, including homebuilder stocks, as well as domestic and global real estate investment trusts.

INTERCONNECTED

A year ago, he wasn’t investing in global REITs, and three years ago, he wasn’t investing in real estate at all.

REITs go well beyond just the market for homes, but most analysts see housing and real estate as being interconnected. Over the past five years, U.S. REITs have generated 6% average annual gains, while global REITs have averaged just over 2%.

But over the 12-month period through March, domestic real estate investment trusts gained 13%, while global REITs gained 27%, Mr. Mahn said.

“We’re seeing terrific growth in the U.S., but we’re seeing even greater growth around the globe,” he said. “It reflects the growing need for housing with the re-emergence of the middle class.”

According to Mr. McMillan, low rates — courtesy of the Federal Reserve — remain one of the most powerful forces driving the housing market rebound.

“When the price of housing gets so high that an average family can’t afford to buy a house, that’s a bubble,” he said. “Right now, mortgages are lower than rents in most places, and the average family can afford two homes, based on affordability measurements.”

Although Mr. McMillan acknowledged that a sudden spike in rates could dampen the housing recovery, he doesn’t anticipate such a scenario.

“The inflation and unemployment levels both support continued Fed support in the markets, and in the short run, I don’t see the supply-and-demand imbalance supporting higher rates,” he said.

“The housing demand is real and the supply gap is real,” Mr. McMillan said. “The interest rates just make it easier for people to do what they were going to do anyway, which is to buy houses.”