As home values continue to rise at a double-digit pace, confidence in the housing market is eroding.
Only 30% of respondents to Gallup’s annual Economics and Personal Finance Survey said now was a good time to buy a home, a whopping 23 percentage points drop from last year. Additionally, in a recent survey by real estate brokerage firm Clever Real Estate, 45% of likely home sellers said they believe a real estate bubble could burst this year.
Concerns about a housing bubble had been simmering for months. In March, the Federal Reserve Bank of Dallas reported growing concern over the possibility of a bubble as house prices continued to rise at a rapid pace.
The fear of a new bubble is understandable. Most people remember the devastating effect of the last housing collapse, including more than 6 million households who lost their homes to foreclosure.
However, those worried about a 2008-style housing bubble might be better served by looking further back in time to see how the current market might evolve.
Why today’s market is different from 2008
In the years leading up to the 2008 meltdown, deregulation of the finance industry made it easier for many homebuyers to access credit who previously would not have qualified for a loan. This caused demand to explode, pushing up house prices and leading to investor speculation and overbuilding.
Loose regulations meant that these same subprime borrowers often found themselves selling alternative loan products such as adjustable rate mortgages or even more exotic products such as those offering lump sum payments. When these rates became adjustable and began to increase dramatically, many homeowners could no longer afford the monthly payments and were subject to foreclosure.
Today’s market is very different.
Based on the fundamentals of the current housing market, a stock market crash similar to the 2008 bubble burst is highly unlikely, says Bill McBride, real estate analyst and author of Calculated risk Newsletter.
The 2008 bubble was characterized by homeowners with adjustable rate loans with a loan-to-value ratio of 105% and interest rates of 1%, McBride notes. Today, ARMs are regulated and have caps in place to prevent interest rates from rising out of control.
Eventually, house prices fell as ARM interest rates began to rise. People couldn’t afford to pay mortgages that were worth more than their homes were worth, leading to a lot of foreclosures. Homeowners today have much more equity in their homes and can absorb a drop in real estate prices without losing all of the equity in their home.
“If prices went down 5% to 10%, people would still have equity and very few people would be in distress,” McBride says. Adding: “I just don’t see how we can get cascading price cuts.”
Instead, McBride thinks it’s much more likely that our current housing market will behave similarly to the market of 1979-1982, which essentially saw a market downturn with no fall in house prices. nor a large number of seizures.
The 1979-1982 period was characterized by even higher inflation than today, with consumer price growth peaking at 13.5% in 1980. As a result, the Federal Reserve, led by the President of the era, Paul Volcker, increased federal funds in an effort to control inflation. Mortgage rates peaked at 18.63% in October 1981 before beginning a slow and steady decline. Today, the Fed is also raising the fed funds rate to stem inflation which is at its highest level in over 40 years and mortgage rates are rising accordingly.
Another similarity to today’s market is the demographics driven demand. Like millennials today, in 1979 the baby boomer generation was the largest cohort to ever enter the housing market at the time and generated huge demand.
The real estate market fundamentals that make a 2008-style crash unlikely
Demographics and Buyer Demand
Today’s strong housing demand is largely driven by a huge millennial generation entering the buying age. This demand, however, has so far been hampered by a severe lack of housing inventory that dates back to the end of the Great Recession.
The construction boom that helped fuel the housing market before the bubble burst in 2008 slowed considerably thereafter. The inventory of available homes in 2010 was 12 months supply, double the 6 month supply considered a sign of a healthy market. At the end of 2019 there was approximately 4 months supply of homes for sale. At the current rate of sales, there is only a 2 month supply of homes available for sale.
A housing market that has enough buyer demand to snap up homes available for sale shouldn’t see prices fall dramatically, notes Skylar Olsen, senior economist at mortgage startup Tomo.
Inflation and interest rates
Inflation has increased over the past year due to economic disruption caused by the COVID-19 pandemic, supply chain constraints and, more recently, the Russian invasion of Ukraine. In April, the inflation rate was above 8% for the second consecutive month. As a result, the Fed raises the federal funds rate in an attempt to curb inflation.
A byproduct of the Fed’s action is that current mortgage rates have risen more than 2 percentage points in the first four months of the year.
However, in an overheated housing market like today’s, high inflation and rising interest rates may not be all bad, according to George Ratiu, senior economist for Realtor.com.
“As I already see prices adjusting in response to higher rates, higher inflation and new supply, this tells me that the market actually seems to be heading towards normalization without bursting like a bubble,” Ratiu says.
House prices have been rising in double digits for nearly two years. In March, home prices jumped 20.9% from the same month last year, the largest year-on-year increase recorded by real estate data provider Corelogic in its 45 years. of history.
Most experts say this rate of house price growth is unsustainable, with many predicting that by this time next year growth will slow to single digits, but prices will not fall.
While high home values may push some potential buyers out of the market, for homeowners it means an increased source of exploitable wealth that can be drawn upon in the event of an unexpected setback.
Homeowners earned a total of $3.2 trillion in equity in 2021, an average of $55,000 per borrower. According to CoreLogic, this represents a 29% increase from December 2020.
Negative equity – when the value of a home falls below the outstanding mortgage balance – has fallen nearly 25% year-on-year, with 1.1 million homeowners underwater on their mortgage at the end of last year. This is the lowest level of negative equity in more than twelve years, according to CoreLogic.
Having enough accumulated equity means homeowners are better equipped to absorb falling home prices or use that equity to cover expenses that may arise without necessarily putting their home at risk.
If we’re not heading for a bubble, so what?
McBride doesn’t see a housing market crash at all, but rather a slowdown similar to what happened between 1979 and 1982, with fewer home sales, less house price growth and less demand. The question is when and how much will the market slow down.
There are signs that a cooling may already be starting. Sales of existing and pending homes are significantly lower this year compared to last year. And while there are signs that house price growth is beginning to moderate, it is still above the current rate of inflation, meaning we are unlikely to see a dramatic loss in value. houses, notes Olsen.
“If house prices stagnated and we still had inflation, then real house prices would fall, but I don’t think house prices stagnate without inflation also coming down very quickly,” Olsen says. . Adding: “I think for the remainder of the pandemic, real house prices will continue to rise.”
Even if prices stagnate, notes Ratiu, that wouldn’t necessarily be a bad thing. Rather, he thinks little or no price growth would be a “welcome sign that the market is finally getting to a normal pace.”
The way forward remains uncertain, although most experts think we are unlikely to see a crash in property prices and a wave of foreclosures.
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