A Real Estate Bubble?
As real estate prices continue to climb and with the stock market being very volatile, it inevitably begs the question of the possibility of another real estate bubble bursting. Of course all of the gold and silver brokers are strongly predicting a real estate crash!
This is always a possibility. I found an article from back in 2006 which accurately identified and predicted some of the precursor’s to that real estate crash. The article cites the following:
When the general public starts to buy property with the intention of making a profit or in the case of 2006, doubling their money in 24 months, the market gets overheated and the bubble becomes unsustainable. Secondly, this giant demand for homes by investors, inherently leads to an over supply of homes for rent. This over supply drives the rent prices down creating a downward spiral in rental prices. When rental prices go down, this naturally reduces the number of buyers in the market because it remains less expensive to rent than to own a home.
The article goes on to say that when the monthly rent received falls below the monthly mortgage payment, that is also a sign of a bubble. The mortgage industries’ response to this is to offer lower down payment loans, easier qualification loans, interest only loans and variable interest rate loans. The article goes on to say that these variable rate loans force owner’s to sell as interest rates rise either as a result of the rise in mortgage payment (assuming they have equity) or the bank sells the property after it is repossessed. Either way, this scenario floods the market with extra homes. This extra inventory drives prices down on homes and potentially crashes the market in an ever downward spiral until the price hits bottom where investors just cannot resist purchasing the homes.
This scenario is exactly what we experienced in 2007-08.
Now lets compare that scenario with what is happening in our local market.
Our market has jumped and jerked its way back to where it would have been had we never experienced the rapid growth in the early 2000’s, the crash of 2007-2011 and the eventually recovery to todays prices. So lets compare our market today as if the crash and recovery had never occurred. In 1996, an Azure model in Rancho Santa Fe sold for $131,000. Today it would sell for approximately $250,000. That means it has gone up 90.8 percent over the past 19 years or an appreciation rate of 4.78%. This rate is well within the normal rate of appreciation for what is considered a healthy market.
The rent versus buy equation also works out in the positive compared to the 2007-08 scenario. Rents are currently keeping pace with the increase in prices. One investor client of mine is trying to get out of the rental business to retire. She raises the rent by 15% at every renewal and I sell the ones that are slow to rent. For the first time in many years, we did not sell any of them because they rented quickly.
I also remember that in the crash, a huge majority of the buyers that were driving the demand for homes and thereby rapidly escalating prices were investors. Many of these investors were cashing out their retirement accounts to purchase homes or buying in a highly speculative manner as fast as they could find something to buy. In contrast, our current market surge is dominated almost entirely by buyers seeking to purchase owner-occupied homes using tried and tested methods of financing. In other words they are normal buyers! Many of the homes they buy are current rental homes thereby further driving the rental prices up.
According to Lawrence Yun, the chief economist for the National Association of Realtors. “Statistically speaking, housing is on a roll. Year-to-date home sales are up 6.3 percent and prices in May were
7.9 percent higher than a year earlier. The trends are expected to stay positive and are likely to boost business dollar volume by as much as 15 percent in 2015. These statistics don't even include new-home construction, which is growing at a strong clip as well.
But this rosy picture does raise concerns about affordability. After all, wages are rising by only 2 percent annually and renters are getting squeezed, having to endure 4 percent rate hikes while home prices accelerate more quickly. In addition, mortgage rates have notched their highest level of the year, reaching about 4 percent in June, and should continue to rise well into next year.
Some armchair analysts have suggested that we’re entering a new housing market bubble. But hard facts suggest otherwise. Underlying conditions today are fundamentally different from the bubble of a decade ago. Back then, credit was easy to obtain and home sales were running at more than 8.5 million a year (existing and new homes combined). New-home construction volume topped 2 million annually.
By comparison, credit today is extremely tight, which has led to an unusually high level of all-cash sales. Home sales are barely over 5 million and new-home construction is barely scratching 1 million units. Meanwhile, for the past eight years, total mortgage balances have fallen. The reasons show what's changed from 10 years ago: Home owners are paying their mortgages on time and few are seeking cash-out refinances.
It's fair to ask, though, whether at some point affordability problems will choke off home buying. That's possible. But here's my thinking about what could neutralize those fears. After running various scenarios, I expect home prices to rise continuously as long as mortgage rates remain under 6 percent. Early in the summer, the average rate was 4 percent. It may rise to 5.5 percent by the end of next year. Should mortgage rates cross the 6 percent mark, maybe two years down the road, then either home prices will be flat or other forces will be evident. Going forward, keep in mind that robust job creation and meaningful increases in income levels will help propel home prices. For now, though, no bubble or impending crash is in sight.”
I know that I do not have a PHD behind my name but everything I can see points to the fact that there is no bubble in sight.