Real Estate Boom or Bubble?
As housing prices have escalated so fast over the past 18 months, many are beginning to call it a bubble. However, are we just in the midst of the beginnings of a housing boom, which may only be the precursor, and perhaps years before, we get into bubble territory?
Let’s refer to the Merriam-Webster Dictionary for a definition of both:
Bubble
- something that lacks firmness, solidity, or reality
- a state of booming economic activity that often ends in a sudden collapse
Boom
- to experience a sudden rapid growth and expansion usually with an increase in prices
To know we are in a bubble, we can only really know for sure after the fact, although there are plenty of tell-tale signs in the midst of a bubble. The only real sign of a bubble today is the rapid increase in prices, however that is also synonymous with a boom. So are we in a bubble or a sustainable boom? How are today’s rapid increase in prices different, or the same, as prior bubbles? The big differences today are in supply and leverage.
Supply
The supply of homes available for sale today on the market is desperately low by historical standards. The average number of newly constructed residential units (single-family & multifamily combined) required per year is 1.5mil units. This is just to meet the average annual demand of new household formation and to replenish old housing. During the run up to the bubble in 2007 the annual rate of new units was running at over 2mil per year, which contributed to an oversupply of units. Then in the years subsequent to 2007 new units plummeted to 500,000 units a year, and only surpassed 1mil units in 2014. It took until December 2019 until the annual production rate surpassed the equilibrium number of 1.5mil units. After twelve years of under production, there is a huge undersupply of units built into the market. There is also a lack of units being listed for sale on the market. For example, in July 2007 there were over 4mil homes listed for sale in the US, compared to early 2021 when only 1mil homes were available for sale.
Leverage
A major factor in the bubble of 2007 was the amount of leverage available to buy homes. Easy financing was made available to home owners and investors alike. Home owners could borrower 100% of acquisition, and in some cases up to 105% to allow for furnishings and moving costs. This created an inherent problem where a home owner had little to no skin, or equity, in their house and had much less motivation to keep paying their mortgage when times got tough. The lax lending standards also encouraged homeowners to take on more debt than they could otherwise afford.
Investors were able to avail of “stated income loans” otherwise known as “liar loans” or “no doc loans”, where all the lender wanted to know was a declaration of your income and/or assets but required no further proof or backup. This allowed investors to pile into acquisitions that they would not have qualified for in normal circumstances, and allowed less sophisticated investors to also overpay for units. Today’s lending requirements are much stricter as a result of the fallout from the banking crisis which followed the housing crash. Underwriting is much more thorough, and leverage is more realistic. Ask any real estate broker today about offers they receive on listings, many of them are cash-buyers, and those with loan commitments typically have sizeable down-payments, unlike twelve years ago.
When we have an inherent built-in undersupply of units for so long, much stricter lending taking place, so many buyers with large cash down-payments, and many buyers having paid all in cash, it’s very hard to call it a bubble.
Price drop or plateau in sight?
Given the aforementioned conditions of undersupply and more sensible lending, what could help slow down the price increases, or perhaps cause a drop? New construction has increased substantially, but it will take some time for the supply imbalance to catch up. A major recession would of course mean all bets are off! Who can assign a probability to that happening with such an active Federal Reserve Bank on watch, coupled with a very reactionary Treasury willing to throw money at the first sign of economic weakness. The most likely cause of a an easing in prices would be an interest rate move. A 1% rise in current interest rates would still have us at an extremely low interest rate, from around today’s 3% to 4%. This compares to the range of 6%-8% in 2000-2002, or 5%-7% from 2003-2007. Each 1% rise in rates has a huge impact on the affordability of the monthly mortgage cost to the borrower, and consequently the amount of money they can borrower. So, what could cause rates to rise…inflation.
Inflation
Back to Merriam-Webster.
Inflation:
- a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services
There are three forms of inflation:
1) Monetary Inflation
2) Consumer Price Inflation
3) Asset Price Inflation
There is a real fear that inflation is creeping up. The Fed has referred to the recent spike in consumer price inflation as being “transitory”, in other words, temporary. It is very understandable to have such spikes in pricing after the pandemic due to supply chain disruptions. These supply chains don’t switch on & off in an instant, and getting them back up to pre-pandemic production can take some time. Once this has been achieved it is hoped that we can return to normal pricing. The Fed has a long-term target to keep consumer price inflation at around 2% per year. The actual number is subject to manipulation however, depending on what is counted within the index.
There are people also pointing to the amount of stimulus that governments around the world have pumped into their economies, which contributes to Monetary Inflation. Governments’ have been essentially printing money in the hopes that people would keep spending and their economies would not go into freefall. The plan seems to have worked so far, but will it create an unwanted side effect of consumer price inflation? If rampant consumer price inflation takes hold, typically the Fed raises interest rates to try and dampen it. If this were to happen, the Fed would also cease their quantitative easing, which would mean they would stop buying bonds in the market. Taking the Fed out of the bond market would increase the yield, or interest rates, bonds would have to offer investors. This would increase mortgage rates.
Most of the monetary inflation from the increase in the money supply seems to have found its way into asset price inflation. A look at the housing market, the stock market, or the cost of any asset class is evidence of this. The Fed, so far, seems less concerned about asset price inflation and is less likely to take corrective action. The recent consumer price inflation looks to be mainly as a result of supply constraints, which should correct itself in time. One area which may have a profound impact on consumer price inflation is labor costs. There is a severe labor shortage in the market. Businesses are having to offer higher wages and better working conditions to entice new recruits. Theses added costs could find there way into higher consumer prices, which may get the Feds attention.
I don’t believe we are in a housing bubble, but we are certainly in a boom time for housing. Price increases should begin abating once more sellers return to the market, and the supply of new construction continues to increase. The biggest danger to house prices is increasing mortgage rates. Any increases in rates should just dampen down the rate of price increase or cause them to plateau. It would probably take a significant jump in rates to cause a housing price correction.
-------------------
If you are in the market for a real estate development or investment property, please let me know if you would like a review of the multiple funding options available to you.
-------------------
New Real Estate Loans
Please contact me if you are in need of real estate financing for an acquisition, refinance, or development project. I’m happy to go through your options and run the numbers.
Call or email me if you would like assistance making your next real estate transaction as profitable as possible.
https://www.mulcahycapital.com
+1-617-861-2042
Mulcahy Capital for Hassle-Free Real Estate Loans.
We provide busy real estate developers, frustrated with financing, better loans in less time, so they make more money.