Are We In A Housing Bubble?
If you’ve been following the Real Estate market over the past few months, you know the story:
Mortgage Interest Rates are higher
Sales are lower and inventory is increasing
Price reductions are back and days on market are longer
Last week rates went over 6% for the first time in 14 years and that’s before the next round of FED hikes. Throw on top of that the FED has pulled back from purchasing mortgage backed securities and we have a housing market that looks nothing like it did earlier in 2022. And that has a lot of people asking if a) we are in a housing bubble and b) is it likely to burst anytime soon.
Multiple offers, bidding wars, waiving contingencies, properties in escrow after the first weekend on the market, that’s all so 2021 and things of the past right now.
Doom and gloom watch: you may have even read the articles predicting that prices will decline 20-25%. Let’s start there.
WILL PRICES DECLINE AND BY HOW MUCH?
Personally, I think prices may decline 5-10% from the top of the market (last May) on certain properties and in some neighborhoods. Others are predicting a 20-25% drop. Let’s go through the math on how people are coming up with this worst case scenario using a hypothetical purchase price of $2,000,000 and a 20% downpayment.
LOAN AMOUNT $1.4M at 3% = $5,902
LOAN AMOUNT $1.4M at 6% = $8,294
My quick math says that’s a difference of $2,392 which is a lot of money for most buyers. To get the payment back to around $6K, the loan amount would have to drop to just under $1M with a purchase price of $1,250,000 and that my dear readers that’s not likely to happen. It would be a 37.5 drop from the top which is far greater than the decline in 2008. (For this analysis, I am not calculating the effect of the difference in property taxes on the payment.)
Here’s what wrong with this entire line of thinking and logic:
“You Can’t Always Get What You Want.
But if you try sometime you’ll find
You get what you need”
For those who don’t quite remember the old Rolling Stones song, that’s the best advice I can give buyers and sellers right now.
Let’s unpack the logic of sellers will have to lower their prices to meet buyer’s budget, which is preposterous on its face.
If I want to buy a Porsche 911 Targa that is retailing for $150K right now but my budget is $100K, will the dealer say sure, we’ll lower the price? I doubt it. They’ll wait until a buyer comes along with a higher budget.
As long as the inventory stays at the current levels or lower, don’t expect prices to tumble 25% or greater.
WHAT’S DIFFERENT FROM THE HOUSING COLLAPSE IN 2008?
Sellers aren’t desperate - people have jobs
Many homeowners are paying less to “own” than to rent
One data point you'll hear quite often is that underwriting standards have been quite high for a long time meaning that home owners have a greater “ability to repay” than in 2008.
Even though there’s lots of recession talk right now, the job market is strong. Most owners are locked into 30 year fixed rate mortgages in the sub 3% range and as long as they have money coming in, are not likely to start panic selling or doing strategic defaults.
WHAT ABOUT THE RECESSION?
There’s no doubt that the housing market is experiencing a recession as of Q4 2022. But per a number of leading economists, the broader economy is not. Yes, there’s inflation for sure but recession is something different.
The job market is strong and most owners are locked into 30 year fixed rate mortgages in the sub 3% range so as long as they have money coming in, are not likely to start panic selling or doing strategic defaults.
Other than mortgage interest rates, fears of recession are the most common concern articulated by buyers right now.
RENTS ARE HIGH WITH NO RELIEF COMING ANYTIME SOON
While the pendulum may have swung right now and for many renting makes more sense than buying, record high rents add to price support for home prices.
Just the slightest relief in mortgage rates - which isn’t coming any time soon, may well tip the pendulum back in favor of sellers.
AS FOR THOSE PRICES…….
WHILE RATES ARE IMPORTANT - EVERYTHING TURNS ON INVENTORY
There were two factors that drove prices higher over the past few years and in particular since 2020:
Low Inventory
Low Rates
Low rates are gone and while inventory has increased there are still not enough properties for everyone who wants to buy. During the years of major price declines, inventory was almost 3X what it is today. And many home owners were competing against a flood of foreclosures and short sales.
Today many sellers will simply decide to turn their homes into rental properties rather than sell for substantially less. And with so many owners have significant equity those that have to sell aren’t going to simply walk away and lose everything. They may accept a lower price at some point but a lot of sellers would have to take a lot less to see the market drop by 25%.
WHAT TO WATCH FOR
Before we all hit the panic button here’s what to look for:
Inventory hitting six+ months of supply a la 2006. What that means is if there are typically 20 sales per month in an area, watch for the inventory to increase to 120 properties.
Distress sales (REOs and Short Sales) to exceed 20% of the total activity. Using the same 20 sales per month, that would mean that there were 4 foreclosures / short sales.
If both of these benchmarks are reached, watch out for falling objects!