Buyers are not buying because of the buying frenzy and now with the rising mortgage rates, they are waiting to see what will happen. Sellers are holding out because, where are they going to go, if they sell? They all want to know when is the market going to crash? It’s a Bubble? Right? If so, when is it going to pop? To answer that question, we must look at our history, trends, and patterns to understand where we are at the present and where are we going?
Let’s begin by defining a “Housing Bubble”, as a sustainable period of house price growth generated by artificial demand, such as loose underwriting or speculative buying. Based on the evidence, there is no expectation that fallout from a housing correction would be comparable to the 2007-2009 global financial crisis in terms of magnitude or macro-economic gravity. Among other things, household balance sheets appear in better shape, and excessive borrowing doesn’t appear to be fueling the housing market boom. It does not imply “Bust”. The house price appreciation does need to slow down, as the double-digit price we’ve been experiencing is clearly not sustainable in the long run. But the high price appreciation is NOT the same as a “Bubble”. And it is in fact supported by fundamentals.
What does that mean? Let's look at the difference between today’s housing market and the housing market boom in the mid-2000s. First and foremost, what is driving the price growth now compared to what was driving the price growth in the mid-2000s? The primary reason in the mid-2000s was the access to a wider range of mortgage finances. You had things like No-doc loans (No documents were needed to finance a loan). Typically, all you needed was proof of income, your W-2s, and pay stubs. It was common to not have verification of income. They had teaser rates, and fixed arm structures based on the market index, when the market went up so did the rate of the loan. Today’s lending practices are much stricter. It’s harder to get a loan today than in pre-pandemic and the median credit score of borrowers approved for mortgages reached 778 in the 4 quarter of 2021, which is significantly higher than during the previous housing boom. The price appreciation we see today is not a result of financial innovation.
So, what is the result? The driving force is supply vs. demand. The supply of homes on the market today remains extremely low. And the homes that hit the market, sell quickly. This is an indication there is clearly more demand than supply. Low inventory combined with lower mortgage rates, the Millennials are moving into their prime buying years, and tighter mortgage underwriting standards are fueling price appreciation. This is very different from the price appreciation during the housing boom that peaked in 2006.
The housing market has been underbuilt since 2009 and we currently are in the midst of a demographic boom. High demand against limited supply is Economy 101 for price growth. The pandemic accelerated the demand as the Feds began a quantitative easing to help the economy, which put downward pressure on the mortgage rates. Not to mention everyone was spending more time at home which prompted a need for more space and allowed for some geographic flexibility. So, the housing market started the pandemic with a supply vs. demand imbalance and over the course of the pandemic, the lack of inventory got worse, while demand get stronger. It is really no surprise that the price growth exploded, nationwide.
But does the strong price growth bode well for the housing market? How does that make this time different from the last time?
The housing crisis in the Great Recession was fueled heavily by the fact that job losses due to the recession were paired with a significant share of homeowners who didn’t have any equity in their homes. It was a dual trigger; you need both the inability to pay and the lack of equity to cause a foreclosure. But homeowners today have very high levels of home equity, which provides a cushion to withstand potential price declines but also prevents housing distress from turning into foreclosure in the first place. In fact, distressed homeowners are required to resolve the delinquency given that they have home equity. By selling the home, the homeowners can pay the mortgage companies what is due to them at closing. Remember the supply shortage issue? It won’t be hard to sell your home, pay off the mortgage and take the equity with you.
Today’s homeowners are not as highly leveraged as they were during the previous housing boom. The mortgage debt to income ratio is near a 4-decade low, with equity at a historic high in the 4 quarter of 2021. Our latest available loan to value, LTV ratio was about 31%, which is the lowest in over 3 decades. And in inflation-adjusted terms, homeowners in the same quarter had an average of $300,000 equity in their homes, a historic high. This makes the homeowner awash with equity today and their balance sheets are much stronger than they were in the 2000s. There is another difference we need to address and that is the lack of speculative buying. Speculation can be measured by the number of speculators or investor sales that are being flipped. It’s true, there are more now, but not at the same levels as before in the mid-2000s. People were buying homes not bothering to make improvements, just hoping to flip and sell them for a higher price. Speculative buying, excessive use of leverage, and poor loan quality, all these things contributed to the last “Housing Bubble.” That is not the case today.
This time housing is not overvalued. We discussed this previously, the measure being, that if the house is appropriately valued, house-buying power should equal or outpace the median sale price of a home. The only period when the median sale price was higher than house-buying power was from 2005 -2007, indicating an overvaluation of housing or a “Housing Bubble.” Today house-buying power is significantly higher than the median sales price of a home, signifying that housing is NOT overvalued. So, no Bubble this time around because Bubble implies Bust.
What is likely to happen? Were in a housing market with double-digit nominal house price growth and now rising mortgage rates. So, if the comparison shouldn’t be made to the housing boom and bust, then what would be a good comparison? Bill McBride, a great housing analyst, says, “Don’t compare the current housing boom to the Bubble and Bust.” He makes a parallel to the 1970s and says a decline in the real house prices and real meaning inflation-adjusted, seems likely. That does not mean a decline in nominal prices. Also, expect a decline in new home starts and new home sales. With solid lending practices, nominal prices there should be a sticky downwards. He does not expect a national decline in nominal pricing. New home sales are more sensitive to rising rates so we may see those decline. Rising prices and mortgage rates will undermine affordability. It will be natural to see some moderation in price appreciation. That’s okay given where we are now. The market will cause the sellers to adjust their price expectations and the house prices will adjust accordingly. But the shortage of supply relative to demand will remain and continue to keep house price appreciation positive. The underlying fundamentals that we’ve been talking about will reflect a moderate decline in prices rather than a sharp decline.
There you have it, we know the real estate market tends to move in cycles, but not every housing boom ends in a bust.
{REconomy from First American Financial Corporation with Odety Kushi, Deputy Chief Economist, and Mark Fleming, Chief Economist}
