Rates Up, Values Up, Bubble Ready to Burst?


In the past year, more Americans have begun to worry that the real estate market is going to crash. Overall, mortgage rates and home values have gone up in 2017 and 2018. A recent survey found that 58% of the people surveyed though that there could be a price correction and housing bubble in the next two years.

There are some potential signs of an asset bubble. First, there is no question the values of homes have gone up substantially in the last several years. National median home prices are 32% higher than inflation, according to some surveys. This is not much different than 2005 when homes were 35% overvalued.

Also, the Housing Bellweather Barometer is a useful index of both mortgage companies and home builders. Last year, this index shot higher just like in 2004 and 2005. It was used by its creator actually to predict the 2008 financial crash. Also, the SPDR S&P Homebuilders ETF has gone up 400% since 2009. The Case Shiller National Index also hit highs at the end of 2016. Price increases are especially concentrated in several major cities, such as Dallas, Denver, Portland, San Francisco and Seattle. In Denver and Dallas, home prices are 40% greater than the peak before the last recession. In Portland and Seattle – 20% and in San Francisco – 10%.

At the same time, affordable home availability has dropped. In 2010, 11% of the rental homes across the US were affordable for people in lower income brackets. By 2016, this had dropped to only 4%. The shortage has been seen in cities where home prices have gone up the most. For instance, the stock of affordable rental properties in Colorado has gone from 32% to 7.5% since 2010.

Echoes of the 2008 Crash?

People who got hit in the 2008 housing market crash are understandably nervous about seeing a repeat of that market. Could another bubble happen? However, some financial experts say that bubble was largely caused by factors that do not exist today. At the time, there were financial products such as credit default swaps, insured derivatives and mortgage backed securities that were very popular. They were supposed to be low risk but were not. With all the demand, mortgage brokers and banks offered loans to almost anyone who applied. This meant there were many buyers in the market who really could not afford a home. People often bought homes thinking the homes would continue to rise in value indefinitely. Many of them were showing irrational exuberance, which is typical in many asset bubbles.

But in 2006, homebuilders caught up with the demand and supply started to outpace the supply. That is when housing prices started to drop. It was reported that home prices dropped in September 2006 for the first time in a decade.

So, it is clear that there are some signs of concern, but here is why we do not see another crash coming:

  • Subprime loans were $620 billion of the market in 2005, for 20% of the market. Today they are only $56 billion and are 5% of the market.
  • Banks have higher lending standards than before. The average credit score for new loans was 686 in 2016 and was only 500 in 2001. It is less likely that people will default on their home loans.
  • Tighter lending criteria mean that flippers have to come up with more cash to invest. Now the lender will only finance up to 55% of the amount.
  • The number of homes being sold today is 20% below the peak of 2005. This means there is just a four month supply of homes to be sold today. So, about 64% of Americans own their home today, compared with almost 70% in 2007.
  • Home sales are not as high because the recession made it harder for people to launch their career and buy a home. With a poor job market, many people decided to stay in school, which now means student loan debt. This means fewer have the down payment for a new home.
  • Homeowners do not pull out as much equity as before from their homes. There were $85 billion in home equity loans in 2006, but only $14 billion in 2017.
  • Homebuilders are focusing more on the higher end homes and not the lower income homes that were popular during the crash.
  • While interest rates are up, not nearly as many people have interest only and adjustable rate mortgages. Because more people have fixed rate mortgages, it is less likely there will be a crash when people’s rates reset to a higher point.

The bottom line is that there are not as many factors in play today that led to the bubble popping in 2008, even though rates and home values are high.


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