The housing market has been one of the strongest parts of the U.S. economy during the coronavirus pandemic but are rapidly rising home prices a warning sign of a real estate bubble? Could the U.S. housing market collapse as it did 14 years ago, triggering a severe recession? Talk to almost any real estate agent or housing expert and they will say no, however, many don’t seem convinced as searches for the phrase, ‘When is the housing market going to crash?’ are up 2,450% over the past month.
In April, home prices surged 19.1% year-over-year with the median price of an existing home reaching $341,600, this according to the latest S&P CoreLogic Case-Shiller U.S. National Home Price Index. This represents the highest increase since February 2006—right before the housing market crashed, sending home values into a free fall. These types of reports also have Americans searching in droves for explanations about why the housing market is so hot and why home prices are rising,
While today’s real-estate market might feel eerily similar to the market conditions that preceded the Great Recession. The circumstances contributing to today’s booming housing market are very different from what precipitated the last boom and bust cycle.
Here are five reasons the U.S. is not in a housing bubble.
1. Tight credit
The housing boom that prompted the Great Recession stemmed from the rise of sub-prime lending. Banks and other mortgage lenders were originating riskier loans — often requiring little in the way of documentation from borrowers to prove they could afford their monthly mortgage payments, and loans that included no money down.
Many loans also featured adjustable rates (ARMs) that ballooned after an introductory period. At the time, homeowners were also treating their homes like ATMs, refinancing into these risky loans to cash out the equity they built up, and even buying additional homes on speculation as “investment properties” using no-downpayment loans.
Lenders are far more cautious today than they were in 2006-2007. Not only is mortgage credit availability much more stringent and limited with banks and mortgage lenders offering loans only to well qualified borrowers with higher credit scores but no-money down loans have all but been eliminated.
2. Favorable Demographics
Today’s homebuyers are purchasing for many healthy reasons: Low-interest rates, more flexibility to work from home and increased saving… all rational reasons for buying a house.
Current demand is also built on a significant growing demographic wave, as we have many millennials turning 30 — a key age for first-time home buying.
The common wisdom in real estate is that people are primarily motivated to buy a home not because of low interest rates or the investment potential, but because of life changes. Millennials are the largest generation — and they are getting married and having kids. As they experience these major milestones, owning a home is becoming a bigger priority.
Strong demand for homes is one of the main reasons a market bubble appears unlikely.
3. Low Inventory
Currently, the U.S. housing market is 3.8 million single-family homes short of demand, according to a recent analysis from Freddie Mac. A low level of new home construction over the past three years has increased that shortfall, which was estimated at 2.5 million units in 2018.
Many home builders were burned by the housing bust of 2008. Prior to it, some companies had engaged in speculative building practices, so when the market collapsed they found themselves saddled with extensive inventories of newly-constructed homes and few interested buyers. As a result, home-building activity slowed considerably.
Home builders have only begun to ramp their operations back up in the last couple of years. In the meantime, many Americans were busy getting married and having kids — creating a huge gap between supply and demand.
New housing starts are rising this spring, but the supply of new homes is projected to remain well below demand. In March, housing starts reached a seasonally adjusted annual rate of 1.739 million units, the highest level since June 2006. Doug Duncan, chief economist for Fannie Mae, says production may decline later this year as homebuilders face supply constraints, such as increasing prices of lumber and other materials.
With only a 2.1-month supply of inventory for single-family homes in March – well below normal levels – home prices are likely to continue to rise. As Lawrence Yun, chief economist of the National Association of Realtors®, says, “This is not a bubble. It is simply lack of supply.”
4. Low Mortgage Rates
One of the biggest drivers of the double-digit price hikes is record-low mortgage interest rates which have put homeownership within reach for the masses. Mortgage interest rates fell to a new all-time low of 2.81% in the week ending Oct. 15, according to Freddie Mac. That’s shaved a considerable amount off of monthly mortgage payments, allowing buyers to stretch their budgets even further.
These get-them-before-they’re-gone rates are giving homebuyers a bad case of fear of missing out. Buyers purchasing a median-priced home today, at about $350,000, are still paying about $80 less than if they had bought a median-priced home of $315,000 last year at the higher average rate of 3.69%.
Based on past econometric modeling, J.P. Morgan Research found that “a reasonable rule of thumb” is a 100 basis-point decline in mortgage rates is associated with a 10% increase in home sales.
As affordability goes up, buyers are willing to take on greater debt because the payment is still in their budget.. The only real limiting factor then is the down payment (it does require more down payment as prices go up) and the level of appraisal gap coverage it takes to beat out the competing buyers in multiple offer situations.
5. Changing Home Preferences
Add in months of being cooped up at home, and what do you have? A flood of buyers seeking larger homes, often with one or more home offices, larger kitchens, and big backyards. These changing home preferences have ratcheted up demand just as the number of homes for sale has fallen to historic lows.
This combination of what could be the lowest mortgage rates of our lifetimes, a paucity of inventory, and a desperate rush of buyers has resulted in median home list prices hitting new records.
A Look Ahead
An Urban Land Institute survey of 43 economists at real estate organizations found little likelihood of a market meltdown. In fact, the economists projected home prices will grow an average of 4.1 percent over the next three years, above the long-term average of 3.9 percent. In a recent forecast, Fannie Mae projected new and existing home sales will be 6.2 percent high than last year, although the pace of transactions will slow later this year.
While we will certainly see a rebalancing at some point, no one can predict when. Rather than seeing a bubble that’s going to pop, we think things are going to calm down, stabilize and rebalance as mortgage interest rates begin to rise, affordability begins to fall, and buyer demand retreats.
Looking ahead to the second half of the year, the pace of home sales may decline and mortgage rates may rise. But those changes should be gradual, rather than bursting a bubble.
If you, or someone you know is considering Buying or Selling a Home in Columbus, Ohio please contact The Opland Group. We offer professional real estate advice and look forward to helping you achieve your real estate goals!
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