With real estate prices rising across the country, many are wondering if the housing market is currently in a bubble. And it is a good question.
When prices are rising in double digits year-on-year, like recently (up 12% yoy in January!), It makes sense to be skeptical of a bubble. Rapid rises in asset prices can be an indicator of a bubble in both the housing and stock markets.
But when I look at the underlying data that fueled the rapid rise in the housing market, I don’t see a bubble. I see a very unique economic environment that has almost completely tipped the scale of the market into a seller’s market, but still a market built on solid fundamentals.
Let’s take a look.
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If we look at the housing market since early 2020, the stock is the predominant force. Well, I should say it lack stock is the driving force in the market.
If we look back at the year 2000, we can see that the fall of 2020 was the lowest that the HUD index “Months of Housing” has reached since the year 2003. People just don’t sell their homes.
The fundamental economic concept of supply and demand tells us that when supply falls, like at the beginning of the pandemic, and demand remains constant, prices will rise. If the same number of buyers want fewer homes, bidding wars ensue – which we all know has become the norm in many major subways.
So that’s the most important factor here: low inventory.
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Above I wrote that when the supply falls and the demand remains constant, prices tend to go up. But what happens if demand also rises? In that scenario, prices tend to go crazy, and this is exactly what we’re seeing right now.
CalculatedRISK charted the index of weekly mortgage applications for purchases (not refinances). As you can see, there was a temporary decline in demand in early 2020, but since then the numbers have stayed on the same trajectory as around 2015. You may notice that demand is slowing down a bit at the moment, which is almost certainly normal seasonality. Buying slows down in the winter and speeds up in the summer.
Demand is growing, but not at an insane pace. It does not peak in a way that seems unsustainable, or in a way that is even approaching where we were in the 2000s. The slope of demand growth is still less than it was in the years between 1990 and 2006.
I think demand is rising for two reasons.
- The pandemic is pushing people to look for a new home in a way that I can’t really quantify (yet). People seem eager to find their nests or to get out of the city and into the suburbs in a more outspoken way than in the past. That’s all anecdotal evidence, but I believe it.
- Interest rates are extremely low, which is a quantifiable and understandable reason why demand is on the rise.
When interest rates fall, mortgages become cheaper and homes more affordable. This is attractive to buyers. Suddenly, a buyer could pay $ 100 less per month for the home he was considering. Or a buyer’s budget can jump from $ 250,000 to $ 280,000. This increased affordability therefore has dual effects: it increases demand (more people want to take advantage of cheap money) and it raises house prices all on their own (people can and will pay more for the same house-bidding wars!).
Look forward to something
To me, these factors indicate that the rise in house prices in recent months is based on simple economics. The supply is low and the demand is rising.
But what we’ve been looking at so far has all been backward-looking. The question on everyone’s mind is, “What’s going to happen now?”
I don’t think we’re in a bubble – and I don’t see the market crashing in the next 12 months. We have these three main factors driving prices up, and while I think they will fall, I don’t think they will change drastically in the coming months:
- The stock is recovering but is unlikely to fully recover in 2021. The start of new homes did not reach pre-pandemic levels until January 2021. There will be a delay in new construction that will help to boost stock numbers even as sales of existing homes increase.
- Demand continues to rise! There are no signs that demand will decline.
- The Fed has stated that it will keep interest rates around zero for the foreseeable future. Maybe even in 2023. That’s great news for mortgage seekers. Bond yields play a major role in mortgage interest rates. Although they have risen in 2021, they have leveled off. If they grow more, it will likely cool the housing market, but not cause any crash.
First, I think the housing market will continue to show above-average appreciation numbers through the end of the summer of 2021. I don’t think they will stay as high as they have been, but still in the 2% + range for quarterly appreciation.
I base this on the fact that the economic recovery looks very strong at the moment. Employment is picking up (the number of new jobs rose from 468,000 in February to 916,000 in March) and the Consumer Confidence Index (CCI) made the biggest jump in years, indicating that people have money and plan to spend it.
Finally, we have not seen the stock return to expected levels, although that could change in mid-summer.
After the summer, I think things will cool. Rather than seeing quarterly appreciation rates in the 3-4% range, I think they will drop to 1-2%. For the historical context, this is not a crash or correction – this is still a good valuation! It’s just more of a return to normal than anything we’ve seen recently.
I base this hypothesis on two things.
- Interest rates are expected to rise from 3.4% to 3.8% by the end of the year. Rising interest rates will cool the market, but a 3.8% 30-year fixed-rate mortgage is still ludicrously low historically. Demand and appreciation are likely to continue to grow, albeit at a slower pace.
- The stock has to recover at some point. My personal belief is that during the worst pandemic, very few people were willing to sell their homes. I think the inventory will increase from May and throughout the summer, and at some point in the fall things will return to normal inventory levels.
My hypotheses are certainly not terribly unique here. Overall, I think many of the big players in the real estate industry are about right.
In their latest quarterly forecast, Freddie Mac predicted that house price growth would top 6.6% nationally this year and decline to 4.4% in 2022. These are both still excellent numbers. Below is their quarterly forecast.
Personally, I think prices could cool down a little faster than Freddie predicts with a slightly stronger drop from Q3 2021 to Q2 2022, but overall I think this is a good analysis directionally. Remember, an appreciation of 4.4% is still very good historically and is likely to outpace inflation, even with inflation potentially rising.
I can’t say for sure what will happen, but personally I don’t see any crashes coming. I think valuation will come back to Earth in the coming quarters and level off, but will continue at a national level. Combined with historically low mortgage rates, it is still a challenging time to buy – if you can find someone to sell you a home.