Betting Against A Housing Bust

Robert Toll and four colleagues are sitting around his office, trading jokes and gentle barbs. The atmosphere resembles a poker game--only instead of cards, the men huddle over a map of southern California. One of Toll's aides points toward a 52-acre parcel of land he's just visited, and now it's up to Toll, America's largest developer of high-end homes, to decide whether he should try to buy it for $7 million and cover it with $600,000 mini-mansions. "It's a piece of desert," Toll scoffs.

"It's a piece of gold," counters the deputy.

"You've got to be kidding me--you're expecting to sell homes there for this kind of money?" says Toll, 61, who started out selling new houses for $17,990 in 1967. He cross-examines his team: What are competitors selling nearby? Is the mountain view really worth a premium? Finally he decides to pursue the deal. "Next..." he says.

Over the next three hours Toll nixes a land purchase in Arizona, greenlights one in Michigan and mulls a half-dozen others. "I'm in," he shouts, agreeing to a contract for $3 million worth of farmland. Then he kisses the proposal. "Killer deal."

Toll isn't the only one with a lot of chips riding on today's hot housing market. Across the country, home prices seem to have escaped the confines of gravity. In the past two years rising home values have added $1.3 trillion to Americans' net worth, and that's helped buoy the stagnant economy and offset plummeting stock portfolios. Last week came more good news: mortgage rates hit 30-year lows, which makes even more Americans willing to spend ever-bigger sums on homes that look better suited for MTV's "Cribs" than a typical suburb.

But as prices keep going up, some observers wonder how long it can last. Two years after the dot-com meltdown, is real estate the new bubble? Most economists (including Alan Greenspan) argue that the price increases rest on a sturdy foundation: low interest rates, strong demographics and a tight supply of homes. Large, publicly traded home builders like Toll Brothers, Pulte, Lennar and Ryland control a bigger piece of the new-home market than they did in the last recession, and they're better capitalized and better managed than smaller builders, reducing the risks of over-building. Housing bulls also point to the rising public outcry over urban sprawl, which limits the land available for new development and drives up values of existing lots. While some local markets may be overheated, "nationally, housing markets are the healthiest they've been in years," says economist David Lereah of the National Association of Realtors.

Still, other experts say housing has nowhere to go but down. More stock declines, rising layoffs or higher mortgage rates could bring this party to an end, they say. And some of them are trying to profit by betting on stocks like Toll Brothers to fall. Says hedge-fund manager Doug Kass of Seabreeze Partners: "Builders have adopted a mantra--'If we build it, buyers will come'--but I think it's going to burn them."

The last time a real-estate boom turned to bust, Robert Toll was able to expand his empire. A second-generation home builder, Toll earned two Ivy League degrees and briefly practiced law before turning to bricks and mortar. By the late 1970s he'd established himself as a successful regional builder outside Philadelphia, but his big break came in the mid-1980s. Land prices were accelerating, and when Toll's executives crunched the numbers, they could justify buying new lots only if they bet on home prices to keep rising. That's too risky for Toll's taste, so he stopped buying land and hoarded cash. When the Northeast real-estate market collapsed a few years later, Toll was flush and ready to scoop up huge swaths of land. Today his $2.23 billion company controls 40,000 residential lots and is building homes in 22 states (average sale price: $518,000). His personal stockholdings are worth more than $350 million.

To get a glimpse of his world--a place of princess suites, bonus rooms, conservatories and dual-staircase foyers--drive through the gate at Belmont Country Club, a Toll Brothers community 25 miles northwest of Washington, D.C. By the time it's completed in 2009, the 1,200-acre development, once a plantation belonging to Robert E. Lee's forebears, will house 1,933 families around a new golf course. They'll have their choice of seven product lines, priced from $350,000 to $1.4 million. The five-bedroom, 6.5-bath Masters model measures in at 7,000 square feet; the basement includes both wine-tasting and plant-potting rooms. One Toll model in Basking Ridge, N.J., features a $1,600 motorized chandelier lift (how else to change bulbs?) and a $1,500 waist-high, slate-lined shower for dog-grooming. In every home, the bathrooms are lavish; during a recent tour, a dozen Wall Street analysts fit into a master shower. But for sheer size check out the unfinished basements. With 3,000 square feet and nine-foot ceilings, a marching band could practice in here.

These alpha homes--some call them McMansions--fuel endless debate. Even as buy-ers customize floor plans, the facades remain depressingly similar. Design pros see problems inside, too, such as over-blown foyers and too many vaulted ceilings. "There's a big difference between making something impressive and making something comfortable," says architect Sarah Susanka, author of "The Not So Big House." Toll, who lives in a 1750 farmhouse with bedrooms that are smaller than the master baths he's building, admits the big homes are mostly about showing off. "Peacocks aren't the only ones with fancy feathers," he says, laughing at how giant Jacuzzis (he calls them "love tubs") have become a Yuppie must-have. "People have an image of producing children in a tub, but I don't think it really works--that's only for fish."

People who buy these homes are happy with the designs--and lately they've been even more pleased by the returns on their investment. In April, David and Pam Moore and their four kids moved into their third Toll house in four years. After just four months in the $800,000 house, they're already refinancing and cashing out $30,000 to build a deck. Other buyers see the current boom as a great opportunity to reap profits and diversify. Scott Hoyt and his family are moving into a new five-bedroom, 5.5-bath home at Belmont. They earned a 40 percent return when they sold their old home (after only three years); Hoyt is banking that gain and, thanks to low interest rates, has a comparable payment on his new house. "Over the last 10 years real estate has been the best investment in my portfolio," he says.

In this fast-rising market, Toll is determined to keep raising prices as fast as he can. Since he assumes housing prices will stay flat when he prices land deals, some Toll communities are on "autopilot": local managers automatically raise prices by, say, $5,000 per home every time they take three deposits. One California community recently raised prices eight times in one weekend. Each Monday evening Toll works until 11 reviewing the deposits received over the weekend. "Come on, it's a vanishing commodity--it's a collector's item," he goads one manager who's resisting hiking prices. (The company never lowers prices for fear of upsetting past customers; if a market softens, it'll discount by throwing in extra amenities.) But they recognize that the price-pushing creates the risk they'll get ahead of the market. "You have to be careful you're not Wile E. Coyote running out on that cliff," Toll says.

The folks betting against Toll and other home builders say it's only a matter of time before they suffer that kind of fall. "Every time there's been a big decline in stock prices, it's followed by a decline in real-estate prices," says Dallas money manager David Tice. Allen Sinai of Primark Decision Economics says the most likely scenario is that home prices will grow more slowly over the next few years, but he puts the odds at 30 or 40 percent that prices will decline by more than 10 percent. Still, most analysts are buying the slower-growth story. Even the economy's recent weakness has a silver lining, they say: it's pushing down mortgage rates, helping buyers.

For his part, Toll seems prepared to ride wherever the cycle takes him. Housing has now gone 11 years without hard times, "so surely we're going to get kicked in the can in the near future," he says. But he makes a strong case that even at today's prices, houses remain a great long-term investment. And Toll expects to be placing bets on real estate for years to come. "It's like shooting craps--you have money spread all over the table," he says. "It's a lot of fun, and as long as it stays fun, I'll keep at it."

It's past 11 p.m. now, this day's deals are done, and outside his chauffeur is waiting. Tomorrow will bring more land offers and more prices to raise. The question--for Toll and the rest of us--is how many tomorrows are left in this boom.