Bubble housing fears are mounting, but any correction won’t be like the last
In the first year of the pandemic, home values defied expectations by soaring. In the second year of living with COVID, real estate prices have skyrocketed again.
US home prices are now at record highs, and the upward trend shows little sign of slowing. The supply of homes for sale remains low and bidding wars are still common, even amid growing affordability challenges and soaring mortgage rates in recent months.
Not the same as 2008
The 2022 housing market is so hot that homeowners, investors and economists can’t help but think back to the housing bubble of 15 years ago and wonder if another heartbreaking crash is in the future. Even normally sober analysts, such as researchers at the Federal Reserve Bank of Dallas, are warning against a settling of scores.
“Our evidence points to abnormal behavior in the US housing market for the first time since the boom of the early 2000s,” wrote a group of Dallas Fed economists in a widely cited report released in late March. “The grounds for concern are clear in some economic indicators – the price-to-rent ratio, in particular, and the price-to-income ratio – which show signs that property prices in 2021 appear increasingly out of step with The fundamentals.”
To be clear, Dallas Fed researchers don’t believe the housing market is on the verge of a crash like the one American homeowners suffered in 2008. In the aftermath of the global financial crisis, home prices in the most bubbly markets fell 50%.
“Based on current evidence, there is no expectation that the fallout from a housing correction will compare to the global financial crisis of 2007-09 in terms of macroeconomic scale or severity,” they write.
Even so, the housing market is overheated and a cooling could be painful, says Ken H. Johnson, a housing economist at Florida Atlantic University.
“House prices have diverged significantly from fundamental prices, primarily due to near-record interest rates, the pandemic and a dramatic shortage of inventory,” Johnson said.
Nationally, home prices rose 20% from February 2021 to February 2022, according to real estate data firm CoreLogic. This kind of sustained ramp-up creates all kinds of economic fallout, as some buyers stretch their budgets to afford homes and many renters find themselves locked out of ownership altogether.
“We’re seeing these gigantic house price increases — and it’s not something we want to continue to see,” says real estate analyst Paige Mueller, founder of Eigen10 Advisors in Alamo, California.
Due to soaring prices, it is becoming increasingly difficult for Americans to afford a home. Only 54.2% of homes sold in the fourth quarter were affordable for families earning a typical income. That number was up 66% in the first quarter of 2020, at the start of the pandemic, according to the NAHB/Wells Fargo Housing Opportunity Index.
Compared to the last housing boom, however, the landing for this surge promises to be much softer, according to many housing analysts.
“Price growth is expected to slow, but prices aren’t expected to fall,” says Oscar Wei, an economist at the California Association of Realtors.
Here are three reasons:
Bubble Buffer 1: A lack of supply
There is an obvious reason why house prices will not collapse: the supply of houses significantly follows the demand for houses.
“I don’t believe we’re in a real estate bubble, and the reason can be summed up in three words: inventory, inventory, inventory,” says Marty Green, principal of Polunsky Beitel Green, a mortgage law firm in Dallas.
Inventory of existing homes for sale reached record highs in early 2022. Although the pressure has eased somewhat, the National Association of Realtors reported only two months supply of homes for sale in March . That’s well short of the six-month supply that economists say signals a balanced market, which favors neither buyers nor sellers.
In addition, new home construction remains well below the levels needed to meet demand. Mueller says US homebuilders completed 1.8 million single-family homes in 2005. This year, that number is expected to be just 1.1 million.
While 20th-century development patterns in the United States were characterized by sprawling housing estates, the land available for this type of construction has mostly disappeared, at least in the more expensive metropolitan areas. Today, developers are focusing on smaller infill projects and turning former shopping malls, office buildings and golf courses into housing.
Bubble Buffer 2: Strict Lending Standards
During the lending frenzy of 2005-2007, anyone could borrow almost any amount of money, regardless of the amount of their down payment or the health of their credit score.
Lenders were offering “no documentation” mortgages – commonly referred to as “liar loans”. Borrowers did indeed lie, sometimes to outlandish levels.
This era of historically loose lending standards proved to be short-lived. The Mortgage Bankers Association‘s Mortgage Availability Index hit an all-time high during this bubble, then plunged to a fraction of that level during the crash. Mortgage standards have remained strict to this day – to qualify for a home loan, borrowers generally need a combination of good credit, high income and large down payments.
Bubble Buffer 3: A growing number of potential buyers
The demographic forces driving housing also appear to be different. In 2005, Gen Xers were reaching their prime homebuying years. There was just one problem: Generation X was not very big, certainly not compared to the baby boomers who came before them.
Much of the demand during the last bubble was driven by baby boomers who bought multiple homes and by enterprising Gen Xers who became real estate barons.
Today, millennials are prime time for household formation. Unlike Generation X, this is a large age cohort. According to the Pew Research Center, there are 62 million millennials, compared to just 55 million Gen Xers.
Meanwhile, with the current housing boom comes an explosion of Hispanic buyers. This group is expected to become a major force in home buying in the years to come.
Geographic results vary
A housing downturn seems almost inevitable, but the contours will vary by geographic location.
“There really isn’t a housing market,” Mueller says.
Underscoring this point, CoreLogic says home price appreciation has varied significantly across the United States. Naples, Florida had the highest annual appreciation rate in February at 41%, followed by Cape Coral, Florida at 40%. In stark contrast to the housing boom, values in Elmira, New York rose only 3%, while Ithaca, New York saw a 5% appreciation.
Johnson predicts that any real estate downturn will play out unevenly. In metropolitan areas experiencing population growth and inventory shortages, house prices are not expected to crash, but instead remain unaffordable. However, metropolitan areas with shrinking populations and abundant supply could experience a slump.
(Visit Bankrate online at bankrate.com.)