Five Signs of the 2006 Miami Real Estate Bubble

Miami real estate prices increased out of control and with no relation to fundamentals during the last five years.  Prices, however, peaked in late 2005 and are now in decline.  With more 100,000 housing units (half of them condos) under costruction or with approved permits, and not enough buyers in sight, prices can only keep going down.  Here are my insights on Miami's 2006 Housing Bubble.

October 28, 2006 

1. Home Prices Disconnected From Rents 

When rents are much cheaper than the monthly mortgage, taxes and insurance payment on a house, there are few incentives to buy.  It is no secret that "investors" buying and flipping houses have been the driving force behind the abnormal price drive-up seen during the last five years in Miami.  At one given point the music had to stop and some "investors" had to be left without a chair.  That is precisely what happened in Q1 2006, the date most experts signal as the end of Miami's real estate boom and the beginning of a slide that may last until well into 2008.  With speculators leaving the market in droves, the large (and growing) number of overpriced houses and condos available for sale in Miami must now be sold to people who are actually looking for a place to live.  With rents about half of a typical PITI payment, plus a time horizon of one to two years with no house price appreciation, nobody is in a rush to buy.  As of October 2006, the Miami real estate market is still way overpriced, with stubborn sellers and unmotivated buyers playing chicken.  My guess is that sellers will blink first and will significantly drop prices, until the gap between the cost of ownership and the cost of renting gets significantly smaller.


2. Wide Availability of Exotic Loans at High Loan to Value Ratios

During my most recent real estate investing endeavors, I've observed that almost nobody uses conventional (20%+ down payment) mortgages any more.  Undoubtedly, this can be partially explained by the low income level of a typical buyer in Miami, compounded with the exorbitant price of houses.  People have been buying houses using risky ARM's ($1 Trillion in ARMs are set to adjust in the next 12 to 18 months, nationwide).  Many of these borrowers don't know how they will make their payments once the interest adjusts.  Some of them don't even know what they've gotten themselves into.  Others have taken piggyback loans (for example, an 80% first mortgage immediately followed at closing by a 15% second, effectively putting only 5% down).  Some piggyback loans are 80%-20%, basically allowing people to buy overpriced houses with nothing down.  It doesn't take a PhD to figure out that many of these loans are not going to be paid, and that all those overpriced houses used as collateral will end up in foreclosure.  In early October, 2006, Florida's foreclosure activity was rated highest in the nation.  The foreclosed homes will only add to the already existing oversupply of homes (41,000+ and counting).  Too Much Supply + Too Little Demand = Falling Prices.


3. High and Sudden Price Appreciation 

Historically, home prices adjusted by inflation have been fairly flat, suggesting that home price must increase roughly at the rate of inflation.  Follow the red line in this graph to see Miami median home prices adjusted by inflation: the line is fairly flat between 1975 and 2000.  Then, it shoots up like a rocket.  That IS the Miami real estate bubble of the last five years (as they say, a picture is worth a thousand words).  Has there been a dramatic change in any fundamental variable to help explain a situation like this?  Not really.  Salaries haven't increased at that pace (in fact, Miami's median income is stagnant and one of the lowest in the nation).  The cost of materials needed to build a house hasn't increased that much (although it has increased some, it has not gone up four times in five years).  Population hasn't increased as dramatically (true, Miami has always attracted immigrants, but not at that rate).  In my humble opinion, speculation plus low borrowing standards are the reason for the housing bubble.  Once one of them (or both) goes away, prices have to fall.  


4. Over-construction

I drive on I-95 almost every day, which puts me at a vantage point to see the multitude of construction cranes that grace the Downtown Miami-Miami Beach-Brickell area.  I used to be amazed at the speed with which buildings went up until about a year ago.  Lately, I've been driving by the same places and see the same cranes, but for some reason the pace of the construction seems to have gone down to a crawl.  Probably, builders are scratching their heads trying to figure out what are they going to do with the 100,000+ housing units (at least half of them condos) that they have been so feverishly erecting.


5. Lack of Affordable Housing

The NAHB/Wells Fargo Housing Opportunity Index, a widely respected housing affordability index, reported in Q2 2006 that only 11.6% of the homes in Miami were affordable (link will open an Excel spreadsheet) for a family earning the median income.  This means that more than 90% of the homes are out of the reach of teachers, police officers, firefighters, postal workers, etc..  It certainly doesn't help when (as corageously reported by Miami Herald) incompetent public servants and corrupt developers conspire to squander millions of dollars of public funds earmarked to build affordable housing for the poor and the middle class.  Some people will vote with their feet and move out to more affordable cities, but most people, however, will stay.  Housing prices must come down to more realistic levels if Miami is to remain a viable place to live.