Are We Re-Inflating the Housing Bubble?

The housing market is in the midst of a recovery. The most recent Case-Shiller index numbers have shown that home prices have risen nationally by 12.1% and in some markets such as San Francisco, Atlanta, Phoenix, and Las Vegas prices have risen more than 20%. This pace is obviously unsustainable. As more people begin listing their homes to try and capture capital gains price appreciation will slow down to a more normalized rate. The question is though are we simply re-inflating the housing bubble and will the combination of higher rates and less institutional capital investment bring the recovery to a halt?

2013’s macro housing data has been extremely strong but according to Goldman Sachs, about 60% of all home purchases this year were all cash. Prior to the crisis that number was 20%. As investors slow down their purchases as REO inventory decreases and rates eke up the rate of price appreciation will certainly slow down. Many people believe that as these cash purchases dry up that there will be no organic demand to pick up the slack and we will see the housing market stagnate. I argue that many people are significantly underestimating the nation’s demand for new housing supply over the next five years.

Between 1997 and 2007 the United States formed approximately 1.5 million new households each year. As the Great Recession hit that number dropped to 500,000 per year despite the US population increasing at roughly the same rate as it did prior to the recession. However in 2012 household formation stabilized and finally outpaced housing starts which means we were finally creating a shortage of homes. Over the last 5 years there has been a buildup of shadow households. As the economy continues to improve, median income levels rise, and unemployment decreases, those households are going to come out of the woodwork and need housing.

Conservatively if we say half of the shadow households will be in the market for a home that means we need to build 1.25 million houses in addition to the new homes we will need to meet the rising levels of household formation that are accompanying the recovery. Simply put there has to be a dramatic increase in new home starts to meet that demand.

Those who say that rising rates are going to curb demand are not seeing the entire picture. Mortgage rates have been much higher without drastically slowing down demand. Even during the housing bubble rates were about 200 basis points higher than they are now and that did not seem to slow anyone down. I believe that over the next 3-5 years we are going to see the housing market continue to heal as the shadow households break into the market and that will overcome any rate hikes we see.

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Best Response

"Those who say that rising rates are going to curb demand are not seeing the entire picture."

Nice commentary, but you also need to look at the entire picture. Student debt levels at historic highs and median incomes rising less than inflation and healthcare costs are two variables that aren't discussed above but are very important to the housing equation. Also, you use 1997-2007 as a reference point, however, one could easily argue that you should evaluate current data relative to a more normalized environment (i.e., not a time period leading up to the housing bubble that soon popped). While I agree general levels of interest rates have indeed been higher, so too have NINJA loans and other mechanisms to encourage household formations that arguably weren't viable (and later proven so via default rates and a pervasive inability to meet mortgage payments). Unemployment rates have been dropping, but for ages 20-24 and 25-29 they are higher relative to the simple headline rates that most people pay attention to - these are prime years to work and build wealth in anticipation of buying a home and thus you may want to look at this as well.

Several other trends (average hours worked per week and the recent trend of firms hiring permanent part-time workers to avoid increased healthcare costs) are also notable and have potential as major headwinds in a housing recovery.

I am not necessary disagreeing with you, but a housing recovery is complicated and I think commentary on a few additional factors would need to be considered.

 

If you are asking me if there is a bubble being built in the real estate market, probably yes. Real estate prices have been going strong. But the real question is would the bust of that bubble lead to another financial crisis? Banks have been much more conservative in originating mortgages since the subprime meltdown. Therefore, the probability of homeowners defaulting on their mortgages is way lower. A spike in foreclosure and resulting credit loss (which is what caused the ripple effect to the broader economy in 2008) is highly unlikely. Even if housing price tanks, the effect would be isolated to a smaller group of well-to-do homeowners and investors. The private MBS market is still tiny and subprime MBS is nonexistent. Weak recovery, yes. Another crisis? Probably not.

 
Rain_Maker112:

If you are asking me if there is a bubble being built in the real estate market, probably yes. Real estate prices have been going strong. But the real question is would the bust of that bubble lead to another financial crisis? Banks have been much more conservative in originating mortgages since the subprime meltdown. Therefore, the probability of homeowners defaulting on their mortgages is way lower. A spike in foreclosure and resulting credit loss (which is what caused the ripple effect to the broader economy in 2008) is highly unlikely. Even if housing price tanks, the effect would be isolated to a smaller group of well-to-do homeowners and investors. The private MBS market is still tiny and subprime MBS is nonexistent. Weak recovery, yes. Another crisis? Probably not.

This comment is right on. Credit underwriting has been extraordinarily stiff and vanilla since 2009 and it continues to grow more strict with each passing quarter. What you're going to see over the next few years is an increase in over all inventory available, sharply higher interest rates as the Fed will be forced to pull back QE3 and a decrease in the growth rate of real estate prices back to more normalized levels. But I don't think we're really in a bubble at this point, but there have been factors that have led to artificially low inventory numbers. The GSEs' new delayed financing rules have really let investors come in with all cash purchases, which has no doubt pushed up cash purchases to 60%.

 

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