Recently I was asked by a reader if the future was looking bleak for the real estate industry. Part of the email reads like this:

"With all your recent writings of interest rates having bottomed, and rates destined to go up (at some point), couldn't a rise in interest rates have some downward pressure on the prices of the mid-priced single family homes in Atlanta that you advocate purchasing? Especially if rates rise without evidence of supporting job growth in the area? Most people who are buying 'starter' homes right now are seemingly maxed out on their debt-to-income ratio. With the cost of borrowed money rising, the only way for these same buyers to make up for this rate rise would be to have a lower sales price."

The question is a logical one. It adds fuel to the theory that price increases over the past years have created a "bubble," which must a some point burst.

The only problem with that theory is that I have been in the residential real estate industry since 1974, and that same theory has been advanced every year since then. I believe that the bubble theory is most popular among out-of-work stock brokers who are envious of the stability displayed by real estate prices over the years.

Here are some thoughts I would bring to the attention of anyone thinking of embracing the bubble theory:

1. Studies have shown residential real estate prices, especially in the low to middle price range, tend to be "inflexible downward." One possible explanation for this phenomenon is that houses serve two roles: as an investment and as a place to live.

Real estate is perceived as a powerful investment and a lifetime goal by most Americans. Furthermore, sellers who can afford to make their mortgage payments will choose to stay in their house rather than sell for less than they paid.

2. Metro Atlanta has been in a "positive job growth mode" since April of 2003, although public perception is just the opposite. As long as job growth in the region stays positive, there will be a demand for additional housing in the area. And all signs are for a continued growth mode in the metro area.

In a recent speech to the Atlanta Rotary Club, Atlanta Fed Chair Jack Guynn said "Looking into 2005, I think our economy is positioned nicely to continue solid growth." He cited 2004 as a "very good year" and went on to say that he "expect(s) this momentum to continue this year and beyond."

The full text of his speech can be found at www.frbatlanta.org under the publications tab, and is very optimistic. If he is right, we will see only moderate increases in interest rates.

3. It is not unusual for people buying their first home to be maxed out financially, regardless of the economic situation. If the real estate industry perceives any resistance to rates, the lenders will shift all efforts to adjustable rate instruments with ultra-low starting and qualifying rates.

In fact, we have already seen this trend with the rush to LIBOR based loans with their "interest-only" payments. While I have counseled buyers and refinancers against these loans because I believe rates will eventually rise, they continue to be popular.

4. The average resale home in Atlanta recently sold for about $159,000, while the national average is substantially higher at $188,500, according to NAR statistics. We are still almost $30,000 below the national average in home prices. In other words, we’ve got room to grow.

5. In addition to everything else, builders can structure new home purchases with "buy-downs" built into the price that make ownership even more easily attainable. All these techniques were abandoned as rates fell in the eighties, but you may rest assured they are available for future marketing needs.

In April of 2002, Federal Reserve Chairman Alan Greenspan testified before Congress about a possible housing bubble at that time. He criticized such speculation as being unlike concerns of an overheated stock market.

He specifically cited two differences between residential real estate and the stock market as making a bubble in housing prices unlikely:

* Real estate tends to have high transaction costs. While not every seller experiences the same expenses, it is not unusual for a seller to pay a commission of 6% to 7%, then also pay some or all of a buyer’s settlement charges, up to as much as 3.3% of the loan amount.

This substantial bite into a seller’s equity has the effect of reducing turnover.

* Opportunities for rapid trading are rare. In other words, investors typically don’t buy in one local market for speculative purposes, then sell quickly when a better opportunity comes along in another market. Most owners hold title for years rather than weeks. This tends to make the market more stable.

Chairman Greenspan also observed that the development of a price bubble in one market would not necessarily have implications for other markets across the nation.

The bottom line: watch for metro Atlanta home prices to advance 3% to 5% in 2005. But I can’t guarantee it.