In Jan. 2005, Alan Reynolds, a senior fellow at the Cato Institute, said that it would be “financially foolhardy” to listen to “housing bubble worrywarts.”
A few months later, Jude Wanniski, a former adviser to President Ronald Reagan, authored a pieced entitled “There is No Housing Bubble!!” – note the two exclamation points.
And even later in the year, Chris Mayer, a professor of real estate at Columbia Business School, and Todd Sinai, a real estate professor at the Wharton School, claimed “basic economic logic” pointed to there being no bubble – and they also compared the experts who thought otherwise to “Chicken Littles.”
They were all wrong.
In recent months, similar conversations about a possible bubble have cropped up around the industry. Prices are rising faster than wages, and credit is loosening up – tell-tale signs of a bubble. But it’s more complicated than that, some experts say.
“The national price gains are not super spectacular, but are nonetheless rising 3 to 4 times as fast as the national average wage growth rate…(and) over credit conditions appear to be loosening,” National Association of Realtors Chief Economist Lawrence Yun wrote in a recent article for Forbes. “However, the suggestion of a new bubble is misplaced, because three major items are left out when looking at the current housing market trends.”
Yun’s Three “Major” Items
The three items Yun was referring to are: credit still being tight relative to pre-crisis years; low mortgage rates allowing people to buy homes without “overstretching their budget”; and the rate of sales versus supply.
Credit: Comparing today’s credit availability with that before the crash, Yun pointed out that the average credit scores for Fannie Mae-backed mortgages today are about 30 points higher than during previous bubble years; scores for FHA loans are about 40 to 50 points higher. Yun also explained that toxic sub-prime mortgages – the kind that were previously approved for borrowers with “strange credit scores and no documentation requirements” – are “virtually non-existent.” It’s the same point Ethan Penner, managing partner of Mosaic Real Estate Investors, made during an interview with CNBC, in which he described the sub-prime loans being issued during the bubble years as simply “bad.”
Mortgage Rates: Also during the bubble years, Yun explained, mortgage payments were eating up 25 percent of people’s income. However, with today’s historically low rates, and assuming a 20 percent down payment, mortgage payments take up only 15 percent of a person’s gross income. Though, that figure varies from market to market.
Supply: In talking about the nation’s current housing supply and the rate of sales, Yun described this combined factor as the “most important item” not being talked about by “new bubble theorists.” While the current market supports an inventory of “4-to-5 months’ supply,” which is concurrent with inventory in bubble years, the rate of transactions is much slower today. “Sales were at a frenzy back then,” Yun wrote.
The Real Problem
If Yun and Penner are to be believed, we’re not in a bubble. Redfin chief economist Nela Richardson recently told CNBC the same thing. The real problem, according to those three, who account for a wealth of real estate experience, is construction: there isn’t enough of it. “We need more inventory, not less,” Richardson said.
Yun wrote that “there is only one sure cure to getting the housing market back into balance and from preventing home prices from rising too fast: more homebuilding activity.”
Penner isn’t worried about rising prices, because he believes it’s what will ultimately stimulate building. “I think that pricing’s an issue for sure, but I think pricing will stimulate more building,” he said. “I don’t worry about a crash.”
But the problem with all of that is affordability. Yun even attributed July’s falling sales to it.
“Severely restrained inventory and the tightening grip it’s putting on affordability is the primary culprit for the considerable sales slump throughout much of the country last month,” Yun said in a statement accompanying the association’s report.
The Affordability Paradox
Demand is congested in the lower end of the market, where Millennials and other first-time buyers are waiting to break into homeownership, but that’s not where builders are building.
In fact, according to homebuilder Will Holder, president of Houston-based Trendmaker Homes, current market conditions (i.e., buyer expectations, cost of labor and materials, lot availability, regulations, etc.) are such that affordable demand can’t be satisfied in the new construction market. “We’ve created a scenario of impossible-to-build, truly affordable homes anymore,” he said. “I, personally, don’t know how to do it.”
Since 2012, home inventory has shrunk by roughly 450,000 homes, according to Trulia. But the share of “premium homes” has risen, from 42.7 percent of the market to 46.2 percent, while the share of “starter homes” has shrunk from 30.2 percent to 27.7 percent. Middle-market home inventory has also dropped.
Richardson speculated that in order to encourage more construction in the sectors where it’s needed, banks will have to loosen access to credit for builders. But according to her, that’s not happening. “Where we need loosening in the market, new construction, we’re seeing banks actually tighten,” she said. “That’s a mistake, especially when you see where the demand is.”
So, to recap: we’re not in a bubble, despite prices running counter to sales, because there remains demand in the lower end of the market, which can be satisfied through building, but current market conditions don’t really allow for affordable building…so it can’t be satisfied.
The next possible solution would come from current homeowners listing their more affordable homes and buying new construction homes or homes in a higher price bracket. But that’s not happening either.
“A lot of (homeowners) are staying put, choosing to renovate and stay in their existing homes instead of speculate on a growing market and get something bigger,” Richardson said.
An Eventual Downturn
In 1997, San Jose State University economist Fred Foldvary made a prediction about the real estate market. He said: “The next major bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as global war.”
Foldvary was right. He based his prediction on a real estate cycle model created by economist Henry George in 1876 (later refined by Glenn Mueller). George observed that real estate markets rise and fall in four phases: recovery, expansion, hypersupply, recession.
Modern day real estate expert Teo Nicolais, an instructor in real estate investment strategies at Harvard Extension School, compared the works of George, Mueller and Foldvary, to make his own prediction: the next crash “won’t happen until after the next peak in 2024.”
And while Nicolais’ prediction might prove true on a national scale, Shari Olefson, attorney and director of The Carnegie Group think tank, believes certain metro markets are already showing clear signs of a bubble.
“Clearly we look at prices and other fundamentals when we’re trying to evaluate whether or not we’re in a bubble,” Olefson told CNBC. “The thing is, in some markets we are seeing that.”
Olefson remarked that yearly national home price increases of 5 to 6 percent are modest, but not all markets are appreciating at that rate. Several are reporting gains in the double digits. According to realtor.com’s bubble index, in 2015 at least 10 metropolitan markets had higher scores than in 2005, when a bubble was imminent.
But still, experts contend that despite bleak numbers, the market isn’t in a bubble. Things are just really expensive.
“The havoc during the last cycle was the result of building too many homes and of speculation fueled by loose credit,” realtor.com Chief Economist Jonathan Smoke told Bloomberg. “That’s the exact opposite of what we have today.”
Source: Miami Agent Magazine
