Buying the Bubble?

With home prices spiraling higher by the day, it's little wonder talk has turned to bubbles. Are we in a housing bubble? Nobody knows. Not John Talbott, whose scary-strong "yes" case is laid out and supported nicely by our own Bill Mann. Not the University of California at Berkeley's Department of Economics, whose study on the subject, though ultimately inconclusive, is a thing of real beauty. Not even Alan Greenspan, who -- and believe me, I paraphrase -- thinks not.

For what it's worth, I think not, too. At least not a bubble such that might be compared to the Nasdaq debacle so recently deflated. Greenspan has, in so many words (so many, many words), convinced me of this. For one, I buy his notion that housing prices are up primarily on low interest rates (affordability) and demand driven largely by long-term and slow-changing demographics. In my experience, these are not the forces that typically inflate bubbles.

In my experience, that's just the old supply and demand. And, yes, imbalances in supply and demand, largely localized, do raise and lower prices. But they can and will do so for extended periods, even indefinitely. Do they inflate bubbles? Not usually, and certainly not in a market characterized by the hurdles involved in buying and selling a home, much less uprooting one's life to do so.

The fact is, investors -- or more precisely (though it's an increasingly fine distinction) speculators -- inflate bubbles. That's not to say that housing prices continue their march higher, nor that we don't see weakness in localized markets, but when we get to the point where homeowners are buying houses purely to sell them at higher prices tomorrow, then we've got a housing bubble.

How do we play this?
We don't. And you know what, I blame the very thought that we should ponder such a question on our mothers. After all, who taught us that a house is an investment (or was it that guy on TV taught us that?)? Historically, houses are appreciating assets, and someday yours may indeed provide a windfall, but it's not an investment. It's where you live; it's where you cross paths with your family once a day. It's maybe the most important (at least, the most expensive) thing you'll ever own, but don't think of it as an investment.

For one thing, it doesn't pay you anything. My father, who grew up in the shadow of the Depression and was never much of a stock guy, once asked me, "But isn't a stock only worth what it pays in dividends?" Forgive me for laughing, but that was 1998, when (1) no stocks you'd ever heard of paid a dividend and (2) everybody was making millions buying stocks expressly for capital appreciation. (Who's laughing now?)

There's a word for buying something in the hopes of selling it to somebody else at a higher price (no, greater fool theory isn't a word). Oh, I remember: speculation. In my father's sense, there are relatively few who invest in houses -- in other words, those who own a home that they rent out for a steady stream of future income. If that doesn't sound like you, you're probably not a home investor.

So don't be a speculator
A few weeks back, I overheard somebody saying that they were considering selling their house and holing up in an apartment until the bubble popped. Don't think my ears didn't twitch at the suggestion. Heck, I was considering moving -- new job, not day trading. I'd be lying if I said I didn't consider seriously whether this might not be just the thing for me.

Funny thing is, the more I ran the numbers, the less I could see how to play it. If housing prices plunged out of the blue and everything else stayed equal, I could make a few bucks. But invariably when I'm warned of a crash, the trigger is invariably rising mortgage rates. Assuming lower prices and higher rates, my payments never seemed to come out sufficiently lower to justify the risk and bother. This is the essence of the affordability index everybody is talking about.

For fun, head to our Home Center, check out today's rates, and take a mortgage calculator for a spin. Enter a loan amount and today's interest rate, and calculate your payment. Now lower the loan amount and raise the rate. How much? Well, that's the trick: Nobody knows how much. Nobody can tell you how much an increase in rate X will affect the price of home Y. What they can tell you is that if you're looking to stay in a home for a long time, homes are historically very affordable today.

Buy it and hold it
If you hold off buying a home today because you think housing prices are heading lower, you're essentially speculating. The same holds if you stretch to buy a home you can't afford because you think it will be worth more tomorrow. As crazy as it sounds, where you think home prices will be tomorrow should scarcely influence your decision to buy or sell your house.

Thus, while your decision to buy a home (and which one) isn't strictly an investing decision, one very important investing principle does apply. Your decisions should be guided, not by the market, but by your own personal situation. A 25-year-old just starting a great new job should start investing -- regardless of what the guy on CNBC says about equity valuations. A 35-year-old with two toddlers should be saving and investing for their college education, regardless.

By the same token, if you are ready to buy a house and have the resources to do so, there seems little reason not to. Sure, rates might go higher, housing prices might go lower. We may, in fact, be in a housing bubble that has a very bad end. But, honestly, what are you going to do? Finding a house you love and leaving yourself a margin of safety is about all you can do. You certainly don't want to be timing this market.

If you like my old man's concept of investing, you definitely want to check out Mathew Emmert and his Motley Fool Income Investor. No speculation there.

Paul Elliott is an editor at The Motley Fool, which has a disclosure policy.