(FORTUNE Magazine) – Everyone from grizzled real estate execs to first-time homebuyers wants to know what's next for home prices. So we'll tell you. Twice. In the bear corner is veteran senior writer Shawn Tully, who's been sounding the alarm about irrational exuberance in real estate since 2002. In the bull corner is new senior writer Jon Birger, who just joined us from Money and thinks comparisons between stocks in 1999 and homes in 2005 are hogwash.

JON BIRGER: So, Shawn, are you ready to apologize to all the FORTUNE readers who postponed purchasing a new home three years ago after you portrayed real estate as a market poised for a fall?

SHAWN TULLY: Hold on, Jon! You're misstating my argument! People who are looking for a house shouldn't time the market. If they plan to live in the home for a long time, they should buy. But with this warning: The gains on that house, even over ten or 15 years, won't come close to matching the huge windfalls homeowners have garnered in the past decade. It's just like stocks: When you buy in at a high price, the future returns are bound to be low.

BIRGER: I don't buy the idea that the price appreciation in recent years has been all that irrational. Bubbles occur when prices are high only because investors believe prices will be even higher tomorrow--not because of fundamentals. And even in an ultra-hot market like California, there's no shortage of fundamental explanations for why prices are high. For instance, since 1990 interest rates on 30-year mortgages have fallen from more than 10% to under 5.75%. According to two New York Fed economists, that drop in rates, combined with the roughly 50% rise in national median income, has resulted in a 130% increase in the maximum mortgage that a family with a median income could qualify for. Guess how much home prices in California have increased since 1990? Lo and behold, it's 131%. Nationally, home prices are up only 104% over the past 15 years--which has led these two Fed economists to wonder whether the question we should be asking is not why home prices are so high, but why they aren't even higher.

TULLY: The huge rise in prices is happening precisely because people believe prices will be higher tomorrow. Remember, prices have jumped around 100% in New York City, Miami, Los Angeles, and most other coastal markets in five years. Rates explain about one-fifth of that jump. But the real problem is that it can't happen twice. Inflation-adjusted rates will not drop from 1.2% to zero. They're far more likely to go back to their historical average of 2.7%. In that case, prices will suffer a one-time shock in the opposite direction. As for the fundamentals driving the boom, the biggest fundamental in housing is rents--it's what earnings are to share prices. Eventually people won't spend $1 million on a house they can rent for $2,000 a month. Historically the ratio of housing prices to rents in the U.S. has been around 12.5; since 2000 that number has jumped to over 17! Expect the number, once again, to go back to the mean. And it's obvious that housing on both coasts is becoming increasingly unaffordable, even with the help of exotic interest-only or reverse-amortization mortgages. Eventually jobs and residents will flee from the high prices.

BIRGER: I'll grant you that there are a couple of markets where the ample supply of undeveloped land makes it hard to justify the huge price increases--Las Vegas comes to mind. And like you, I'm no fan of interest-only and other mortgage exotica. But I'd argue that the statistics trotted out by bubble mongers grossly inflate the actual price appreciation taking place. For instance, I'd have to pay 45% more today for my Larchmont, N.Y., home than I paid five years ago--not the 75% reflected by the OFHEO home-price index for my region. The problem with OFHEO numbers is that they include only homes purchased with mortgages below $360,000 that can be bought or backed by Fannie Mae or Freddie Mac. That's a big distortion, considering that the low end of the market is where most of the speculation takes place. It's like judging the equity market based solely on $5-or- under stocks. There's another, even more comical, flaw in the OFHEO data: These geniuses make absolutely no adjustments for property improvements! If I buy a home for $250,000, spend $100,000 on renovations, then sell it for $380,000, the entire $130,000 difference would be treated as appreciation. TULLY: Jon, areas with high home prices and no job creation are vulnerable to large decreases in prices--we saw it in Boston and New York in the early 1990s. San Francisco is facing the same problem today--price appreciation in California is far outstripping gains in personal incomes. And in New York and Boston, employment growth has slowed to zero. Another "affordability" factor that the bulls mostly ignore is the explosion in real estate taxes. In many suburban areas--northern Virginia, New York's Westchester County, and the Boston area--they're rising far faster than inflation, in many towns, ten points faster. When prices start falling, property taxes won't fall with them--local governments need the revenue too much. Looking forward, property taxes will be a major negative for real estate.

BIRGER: Shawn, in New York and Boston in the early 1990s, the price decreases we saw correlated nearly perfectly with the implosion of the local job markets. In New York it was Wall Street that took it on the chin. In Boston it was technology and manufacturing. Frankly, with Boston losing 115,000 jobs between 1990 and 1992, I'd argue it was a minor miracle home prices fell only 13%. With every regional drop in home prices the cause has always been recession and accompanying job losses--not speculation. Furthermore, I have my doubts about how much speculation is really going on. The National Association of Realtors claims that 36% of homes purchased in 2004 were investments or vacation homes, up from 6% in 2003. Turns out, though, that gap is largely attributable to a methodology change. The NAR switched from mailing its surveys to e-mailing them; the response rate from investors was quite low before the switch, as very few people respond to mail sent to addresses where they don't actually live. Moreover, when Wachovia housing analyst Carl Reichardt crunched numbers from the U.S. Census Bureau's American Housing Survey, he found that the share of the housing pie owned by investors had actually fallen, from 18% in 1991 to 15% today. So why are we reading so many bubble stories in the media? I think there's a ton of collective guilt over failing to sound the alarm over the tech bubble five years ago.

TULLY: You've got to be kidding. Buying for investment is rampant. The U.S. is generating about 1.2 million households a year, yet over 1.7 million homes and condos are being built. And I don't agree that only a recession can trigger a fall in real estate prices. High prices for real estate, like high prices for everything else, are self- correcting. Eventually people take the money and run. We're seeing that phenomenon in the migration of homeowners from L.A. and San Francisco to cheaper places like Las Vegas and Phoenix. Most homeowners stay put when real estate hits a rough patch--but not the owners of third and fourth homes. Prices will fall sharply in the overheated markets that aren't creating jobs--like New York, Boston, and San Francisco --and at best go flat in areas with modest job growth, notably Southern California. But we're in for years of poor returns.

BIRGER: Who's kidding who? If people are taking the money and running in San Francisco and L.A., why are home prices there still rising at double-digit rates? For all your talk of overbuilding, housing starts in the U.S. are at lower levels today than they were in the 1970s--when the population was about 30% lower! Thing is, even if prices do eventually fall, if you delay purchasing a home or sell an existing one to rent, your timing better be darn near perfect. Remember December 1996, when Alan Greenspan first cautioned stock investors about "irrational exuberance"? Well, the market more than doubled over the next 3½ years, and even at the market low, prices didn't fall to December 1996 levels.

TULLY: The run-up in home prices has proved good therapy for people who lost their shirts on tech stocks. In their own eyes, they've redeemed their pride as investors. But instead of learning the lesson that the fundamentals always win, they're buying a new era of ridiculous arguments. The biggest problem for the bulls is that housing prices are far higher than the costs of buying the land and putting up the houses--so developers are making tons of money. As houses keep pouring onto the market, prices will drop. The market is working in real estate. And it's bad news for the bulls.

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