Indicating that the housing bubble is alive and well, homebuilder Lennar (NYSE:LEN) yesterday reported record earnings per share and raised its earnings estimate for 2005. On the news, the stock shot up over 10% in trading yesterday.
Lennar's strong results came in less than a week after competitor Toll Brothers (NYSE:TOL) reported that its fourth-quarter profits nearly doubled, and both companies indicated that demand for new homes remains strong. Despite the fact that the Fed has now raised short-term rates five times since June to 2.25%, long-term mortgage rates remain attractively low and housing demand remains robust. In addition, REIT stocks are also trading at historical highs, and real estate is increasingly driving the valuation of retail stocks such as Sears (NYSE:S), Home Depot (NYSE:HD), and Kmart (NASDAQ:KMRT).
Also this week, the Economist released its quarterly global house price index. In the third quarter of 2004, housing prices in the U.S. surged 13% over the prior year -- the fastest increase on record. In some states, including California, prices increased by more than 20% in the past 12 months.
Is this sustainable? As I have written in the past, I don't believe it is. But many people do, including Fed Chairman Alan Greenspan, who recently argued against the existence of a housing bubble in a speech to a group of community bankers in October.
Based on an analysis of the ratio of home prices to incomes, the Economist now believes that American housing prices are almost 30% overvalued. The Economist also predicted the bubble in technology stocks -- but it first started sounding the alarm about overvalued technology stocks in late 1998, when the Nasdaq was trading below 2,000. From that point, technology stocks more than doubled before the bubble ultimately burst.
Even if there is a housing bubble, prices could continue to increase for a several years or more before a correction occurs. As Paul Elliott advised over a year ago, homeowners shouldn't be trying to time the housing market (or any market, for that matter), and they should ensure that they have an adequate margin of safety so that they are financially secure when housing prices do adjust. Though I have no idea when a correction might occur, I am confident that housing prices will ultimately return to more modest valuations consistent with economic fundamentals.
Fool contributor Salim Haji owns a home in Denver but does not own any of the stocks mentioned in this article.
