As the housing market swells to a staggering 14.8% yearly price growth, the question on many people’s minds is echoing the one that dominated in 2008: “Are we in a housing bubble — and when will it burst?”
It doesn’t help that pandemic-driven home purchases and CARES Act mortgage protections feel fleeting by nature. However, the real estate experts we spoke to say we’re not in a dramatic peak-and-collapse pattern. If we were, we probably wouldn’t have such a low supply of homes and stringent lending criteria for buyers right now.
In this guide, we’ll dig into:
- How the current housing boom differs from the time period leading up to 2008
- Valid concerns and risks to the current market
- Warning signs of a bubble and what to watch for
- Sentiment about the housing market moving forward
‘Correction, not crash’
As of Nov. 25 2020, the average 30-year fixed mortgage rate remained at a record low 2.72%. On top of that, more people are working and schooling from home, leading them to care more about finding the “perfect” house in which to hunker down.
The increased demand has led to a steady rise in home prices almost nationwide. Sherry Ajluni, a top real estate agent in the Atlanta metropolitan area, estimates that prices in her market are up 7%-10% over this time last year, and inventory is at the lowest level she has seen in her 15 years in the industry.
“We’ve had a good market since 2011, a good 10-year run,” she says. “Any decline won’t be a crash; it will be a correction. We tell our clients that the average correction means a slight decline over a period of 18 months to two years, so if they’ll be in their home for the next five years, they should be fine.”
All of this sounds like great news for homeowners. But anytime the U.S. housing market stays strong for an extended period, people worry that we could be in a housing bubble.
Housing bubbles, explained with tulips
Would you pay six times your salary for a tulip? Likely not — but in Holland in the 1600s, many people forked over thousands of dollars to get their hands on the coveted flowers.
During “Tulipmania,” tulips were so rare and the demand for them was so high that their prices skyrocketed up to $5,500 per bulb. But by 1637, the passion for tulips faded and the “tulip bubble” crashed, as buyers who’d purchased the expensive bulbs on credit found themselves unable to repay their tulip loans.
It sounds like a silly parallel, but the same pattern can occur in a pricing bubble for any item of value, including housing. When investors, otherwise known as speculators, begin snatching up properties at a higher rate in hopes that prices will continue to rise, inventory starts to shrink. Then, as prices climb above the appraised value of homes, demand tapers off and inventory starts to build back up.
Home prices begin to “revert to the mean,” which means they snap back to the historical average level seen before the run-up. As a result, the people who purchased while the prices were escalated can end up underwater on their mortgages. The bubble bursts.
But until it bursts? A housing bubble looks very much like a hot market. Nothing is more informed than hindsight, but there are a few warning signs that indicate a potential bubble on the rise:
Sharp rise in foreclosure filings:
With the housing crash that led to the Great Recession, foreclosure activity spiked 81% in 2008, a surefire sign of a widespread collapse. The glut of foreclosures led to an increase in inventory, which then triggered a fast decline in home prices. A really bad situation for anyone who had overextended to buy a house thinking it would appreciate fast, only to realize they’d have to sell the investment at a loss.
Relaxed lending requirements:
One of the biggest drivers of the 2008 crash was loose lending criteria, which resulted in many homeowners facing mortgage payments they couldn’t afford. Homebuyers eager to take advantage of low interest rates in the early 2000s were met by predatory lenders who lowered their credit and down payment requirements, even for risky borrowers.
According to the Joint Centers for Harvard Studies, the percentage of subprime mortgages — or those mortgages which carry a higher interest rate than prime loans and are provided to people with impaired credit — rose from 8% of originations in 2003 to 20% in 2005 and 2006. As a result, when home prices crashed, many mortgage holders were left underwater and forced to foreclose, creating a glut of housing supply.
An increasing supply of available homes:
As inventory creeps back up, buyers have more options and the market gradually shifts to their advantage. Sellers then respond by lowering home prices in a bid to attract offers. The National Association of Realtors tracks existing home inventory with its monthly Existing Home Sales Report, while The Census Bureau measures the supply of new construction — both good resources for keeping track of home supply trends and what they could be indicating about a potential bubble.
Low contract-to-listing ratio:
If there are fewer houses going to contract compared to how many are on the market, this could be a forward-looking sign of impending market strain. To calculate this number, you would divide the number of homes under contract by the total number of homes currently on the market for any specific price range.
For example, if there are 30 homes under contract and 40 listed for sale, that would be a 75% contract-to-listing ratio. If, in the next month, there were only 10 homes under contract and a total of 44 homes listed for sale, that would be a 23% contract-to-listing ratio.
That downward pattern in contract-to-listing ratios over time could be a sign of the market cooling fast. Smith recalls that during the 2007-2008 housing crash, listings lingered on the market for longer periods, sometimes for over a year. “It wasn’t unusual to have 25 or 30 listings at a time,” she says.
Rate of real estate contracts falling through:
Contracts can fall apart in a thriving market, especially when there are contingencies involved. In a survey by the National Association of Realtors in September of 2020, roughly 6% of contracts were terminated for various reasons. That said, if the rate of busted contracts starts to rise month over month, that could be a red flag that buyers are backing out due to unforeseen circumstances like job loss.
Current market risks
So we know there’s a general skepticism or unease about what’s on the other side of this rather surprising post-COVID housing boom — but what is triggering the concerns?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law in March of 2020 to provide more than $2 trillion to American people and small businesses to help them weather the economic storm caused by COVID.
In terms of homeownership, CARES offered a moratorium on foreclosures and evictions, and also allowed them to request up to 12 months of mortgage forbearance. In addition, the Act sweetened unemployment benefits with an extra $600 weekly booster.
While this may sound like good news, there has been some concern that the expiration of the CARES Act would result in a wave of foreclosures when homeowners were suddenly unable to cover their bills. Forbearance, after all, is not debt forgiveness. Eventually the mortgage payments will come due.
As record-low interest rates entice buyers to stretch into higher price points and seek larger mortgages, many markets are seeing overpriced offers. According to one survey of 1,000 buyers who purchased homes between January and May of 2020, more than 40% ended up in bidding wars. While making offers over asking price might bring a buyer’s dream home within reach, it also raises their risk of taking a loss on the property down the road.
Certain pockets of the country may be more at risk than others to the impacts of the pandemic. According to a July report from ATTOM Data Solutions analyzing home affordability, home equity, and foreclosures, the housing markets most vulnerable to pressures like job loss and economic strife include those on the East Coast and in northern Illinois, particularly in New York City, Baltimore, Chicago, and Washington, D.C. States on the West Coast had the lowest risk, the report stated.
How 2020 differs from 2008
The U.S. has navigated through several recessions in its history, but the prime example of a modern-day housing bubble is the 2007-2008 crash that led up to the Great Recession. All told, in 2008 foreclosures spiked more than 80%, 8 million Americans were at least a month behind on mortgage payments, and U.S. homeowners lost a total of $3.3 trillion in home equity.
One of the underlying concerns amid the current real estate boom is that we could be headed toward a reprise of that sharp drop-off 13 years ago. Taking a closer look at the key differences between the two scenarios could help assuage some of those fears.
The criteria banks use to either issue or deny loans has a direct impact on the strength of the housing market. Lending standards look very different today, even amid the fallout from COVID-19, than they did in 2008.
One of the primary culprits in the 2007-2008 housing crash was lax lending requirements. Lenders were handing out a large number of subprime loans to consumers who probably wouldn’t have qualified in today’s lending environment. According to Forbes, in 2006, only one of the top 25 subprime lenders were subject to the standard mortgage regulations. Those nonbank lenders issued more than 12 million subprime mortgages, totalling almost $2 trillion.
“The main difference between the crash of 2008 and the current housing market is that today’s lending standards are nowhere near as lax as they were 12 years ago,” says Andrina Valdes, COO of Cornerstone Home Lending, Inc, a full-service mortgage lender founded in 1988.
She points out that the Urban Institute’s HCAI (Housing Credit Availability Index) — which measures the share of home loans that are likely to go more than 90 days unpaid — is still low, meaning that it appears the market is still trending below the level of default risk that could cause a crash. In the wake of the pandemic, many mortgage lenders tightened their standards for borrowers by increasing their credit score and down payment requirements in an effort to further minimize default risk.
Supply of homes
The health of any given housing market revolves around supply and demand. When demand is high and supply is low, prices rise. When inventory is high, prices naturally fall as sellers must become more competitive to attract buyers.
Leading up to the crash, newly built homes were flooding the market, causing an excess of inventory. Residential construction had averaged less than 4.5% of the GDP in the 20 years or so leading up to the late 90s, but by the end of 2005, it had spiked to nearly 6.8%.
Pam Smith, a top-selling real estate agent in the Dallas/Fort Worth area, worked all through the crash. “As a buyer’s agent, it was difficult because there was so much inventory that buyers had a hard time choosing a property,” she recalls. “I had one buyer who saw over 70 houses before finally making a decision.”
Considering 6 months of inventory constitutes a balanced market, the supply of new homes in today’s market remains extremely tight at 3.3 months of supply compared to a supply of 5.5 months the year prior. A report from Crain’s New York sheds light on what’s holding builders back, namely, the rising cost of lumber made worse by the California wildfires — and a scarcity of labor.
These factors give builders an incentive to slow down the pace of construction and keep home prices high to cover their margins. In addition, more than 60% of agents surveyed by HomeLight cited a lack of supply to meet demand as the biggest challenge in this year’s real estate market as buyers flood the market.
Are we at risk of another housing bubble popping?
Scars from the Great Recession still linger, casting a shadow of doubt on the validity of any housing market boom, especially in a time when the GDP plummeted more than 30% in a single quarter and unemployment is still close to 7% as of October 2020. And for those who weathered the fallout of the 2007-2008 crash, there is always the ongoing worry that history will repeat itself.
With home sales and prices on the rise and mortgage rates hovering at near-historic lows — and with that activity forecasted to continue into 2021 — are we at risk of another crash?
Key indicators point to a strong market that isn’t just smoke and mirrors. According to the NAHB/Wells Fargo Housing Market Index, homebuilders report all-time-high confidence in the strength of the housing market (85% as of October 2020). “The housing market continues to be a bright spot for the economy, supported by increased buyer interest in the suburbs, exurbs and small towns,” said NAHB Chief Economist Robert Dietz.
Meanwhile, mortgage rates remain low, and a survey of 100 real estate experts, investment strategists, and economists found that respondents are even more optimistic about the housing market now than they were prior to COVID-19.
Valdes says it’s clear that today’s housing market is nothing like it was in 2008. In fact, she believes the market has recovered much stronger than anyone expected and is currently a driving force for the entire economy. Perhaps most telling, for the seventh year in a row, a Gallup survey has shown that real estate is still considered the top investment for Americans.
Header Image Source: (Michael Olsen / Unsplash)