Is a Housing Market Crash Coming?

To answer this question, “will the housing market crash”, we need to ascertain whether we are in a bubble.

An asset bubble occurs when there is a sharp rise in the price of an asset that is unsupported by the underlying fundamentals. Are we in a housing price bubble? Well… sort of.

Home prices remain grossly inflated, but the consumer / borrower and the overall economy remain quite strong post-pandemic.

This Is Not the Financial Crisis of 2008

We do not have the makings of the Financial Crisis of 2007-2008 where the mass securitization of bad loans to noncredit worthy borrowers tanked the entire economy.

During the housing crisis, borrowers were living in homes that they simply could not conservatively afford if they dealt with rising interest rates.

The real estate market, including commercial real estate AND residential real estate, was stretched thin.

People with limited assets and minimal savings were securing mortgages that they had no business getting should the economy sour. After they got their mortgages and moved into their McMansions, they began using their homes like piggy banks, borrowing against them to fund their bourgeois lifestyle.

And then when values depressed, borrowers found themselves underwater holding mortgages worth more than the value of the home. Shame on the lenders, the underwriters, the real estate agents, and the would-be homeowners.

Now, there are more responsible ways for those struggling to save to buy a house with no money.

A bit oversimplified and certainly defamatory, but you get my point. The housing crash was certainly avoidable with its stampede of warning signs.

The real estate backdrop today is different.

What I am seeing is the result of several things:

1. Housing supply and demand imbalances are driving up home prices in various markets.

Builders have ramped up construction, but the number of new homes is not sufficient to meet the demand side. For example, the exodus of retirees moving from the Northeast to places like Florida is staggering. Every neighbor I have is a retiree and a transplant. Literally. Which is perfect as they wouldn’t allow me to move into the seniors-only community, which I actually preferred, across the street.  

2. Borrowers are relatively flush with cash.

This is due to a variety of things, including Uncle Sam’s pandemic stimulus checks, an improved household savings rate, an increase in liquid retirement assets, wage increases, etc. People are also using the appreciation in their existing homes, taking advantage of the seller’s market, and either upsizing or relocating with the proceeds.

3. Historically low borrowing rates.

There was never a better time to secure a mortgage for your dream home.

Twenty year and thirty-year fixed rate loans were at historic, all-time lows. I say “was” because rates are rising courtesy of a hawkish Fed targeting high inflation numbers; easy money will quickly become a little less “easy” when the Fed tightens.

And you know the Fed – they are reactive and rarely proactive.

I want you to think about this. In the late 70s, my parents bought their first home and secured a mortgage for a little less than 10%. My dad felt good about that.

He also felt good about me marrying my first wife solely for her good looks. In his defense, she had those in spades. Enough said.

Check out the 30-year fixed rate mortgage average below. Mom and Dad financed our childhood home right before we saw some of the highest rates in history. I believe they paid less than $40k for our home, which has since appreciated more than 20x in 40 years. When I called mom to inquire, she said, “yes, and my parents bought their home on Long Island, New York for $7k.”

Source: *The Gray areas are indicative of a recession.

**If you didn’t refinance your home, your car, your student loan, or some other element of your loan portfolio you are the last man standing. Literally. You are the last one. Maybe go and take care of that now.**

4. Broken supply chains have driven up materials and labor costs.

Inflation nation. Higher labor, lumber, and other material costs have made it challenging to build homes at lower price points.

Our readers made a small fortune on several of stock recommendations – we remain bullish on builders, transportation, shipping and logistics companies for 2022. The Investor Weekly’s portfolio includes many of these types of companies and they are our highest performers.

5. The housing moratorium.

Or should I say the foreclosure moratorium and forbearance on payments on government-backed mortgages. This prevented distressed sales of foreclosed homes, which steeply discount home prices. Truth be told, there were amazingly few foreclosures during the pandemic.

6. The work from anywhere craze has further powered demand.

We have seen big cities like NY, Boston, Chicago, LA, and DC, etc. shed their local domestic labor force during the pandemic. Millions of apartment dwellers relocated to the suburbs, exurbs and smaller cities. For the first time, these remote workers were driving up housing markets where existing prices looked like bargains compared to what they were paying in the city.

Do all bubbles pop?

Some do and some don’t. The ones that don’t tend to deflate gradually.

And that is what we are going to see in the housing market – broadly speaking – a gradual deflation of home price value.

To be fair, in the coming 24 months, there will also be pockets of stability and pockets of severe value loss in terms of home sales. But it is my prediction that we will not see a complete collapse of the housing market. Prices should move sideways and allow for incomes and the cost of construction inputs to catch up.

When home prices rise this fast, they become disconnected from the purchasing power of would-be buyers.

Some first time home buyers have even began looking at alternatives. Prefab and modular homes have become increasing popular among millennials looking for a cheaper buying experience of living off-the-grid.

For anyone paying attention, housing prices have risen more quickly than income. This is mainly due to the extremely low interest rates being offered to home buyers.

Nationwide home prices are overvalued by as much as 15 percent. And in the South and West I’d say they are overvalued by more than 20 percent.

Home Prices – Boom Towns Are Going to Bust

Housing prices remain red hot. And I am not referring just to upper class neighborhoods in big cities or resort towns. The entire real estate industry is on fire. Markets are hot in the suburbs, exurbs, in cities and in rural areas.

Prices were rising well before the pandemic but have really been on a tear as of late. Median home prices are more than double what they were a decade ago – roughly $350,000. This level of home price appreciation doesn’t seem sustainable.

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Home prices rose by 18.8% annually in December 2021. It is harder today than ever before to find an affordable home.

Mortgage rates are creeping up. Rates are nearly 75 basis points higher (0.75%) today than they were a year ago.

My partner bought a new home for a base price of $450k and put roughly $100k of upgrades into the home in 2021. Mind you, the base price of this same home was $300k in 2019.

In the past 12 months, the home has risen in value to $680k.

Our neighbors down the block just sold their home and made a tidy $300k profit in the last two years with only 20% down at the time of purchase.

Any fool can see this sort of growth just doesn’t add up. A housing market correction must be imminent.

Fantastic for my neighbors who sold, but for the buyers who bought the house? Maybe people forgot what happened to the market in Miami about a decade ago. Many real estate investors who got in at the height of the real estate bubble still haven’t made their money back.

Let me be clear, investing now may prove to be a very bad thing if you intend to sell in the near run. I built a mortgage calculator. You’ll like it. Go ahead and download it. I generally run an appreciation factor equivalent to GDP or slightly below. Say 2 to 3% to be conservative.

For the math wizards out there, a quick Future Value analysis shows $550k goes to roughly $567k in 18 months at 2% appreciation. That makes sense. I am good with that. But what about the $680k? This equates to an appreciation factor of 1.15 or 15%. That is absurd.

The Most Overvalued Housing Markets

Many of these names are still on the list of the fastest-growing markets. This means that their prices will likely stabilize in the future.

When will that happen? No one knows for sure, but if we have reached a peak in the current housing cycle this will be sooner than later.

In the event you were wondering, Boise, Idaho remains the nation’s most overvalued market. Prices are up more than 75% since November 2021. This is considered a rapid price increase. Look at this little gem I found for a mere $700k. Looks like a steal to me.

Oh and here is another beauty for just shy of a million. Hell, I’d buy it just for the landscaping… Another housing market potentially stretched to its limit.

Sellers Need to Brace Themselves

They say that life is all about timing.

I believe that sellers in the next 24 months will need to brace themselves for a very difficult time if they are attempting to get the highest value for their home. Housing markets are beginning to settle in western markets. Data is already starting to suggest that places like San Francisco and Los Angeles are showing signs of a pricing crown. Is this surprising? No. That is because the largest levels of separation between actual and projected home prices have occurred to this point in the West.

This stands in contrast to most Eastern markets where home prices continue to rise. Buyers continue to pay steep premiums in places like Atlanta, Georgia and Charlotte, North Carolina.

According to Zillow, instead of inventory levels beginning to normalize this year, the situation is getting worse. And a lack of inventory means buyers will bid up prices well into the Spring of 2022.

In January 2021, the number of homes for sale was 26% below the level hit in January 2020. In January 2022, that number was 42% below January 2020.

Source: Zillow

Not everyone agrees with Zillow, however. CoreLogic sees home prices climbing 3.5% and Fannie Mae predicts the home price index to grow by 7.6% this year.

I find myself in the later camp, when compared to Zillow. As rates rise, many buyers are going to be completely priced out of the market. I believe the cooling effect will ice out many of the buyers currently waiting on the sidelines.

What about Buyers?

On the other side of the coin, buyers should be ready for depressed home prices. However, they should also be prepared to see much higher mortgage rates than we are seeing today. Maybe 100bps (1%) to 200bps (2%) depending on how aggressive the Fed, aka the Federal Reserve Bank, is when they raise interest rates.

Is the Market Speculative with Investors?

Right now it does not appear that house flips are a serious concern. House flips are defined as an arms-length sale within one year of the previous sale.

What we tend to see today are investors purchasing older homes in less bubble-prone markets. These markets are mostly in the Northeast and Midwest. Flippers purchase the homes, renovate them and then move to quickly sell them.

Housing investors today are largely composed of well-established companies focused on longer-term real estate investment horizons, compared to the bubble of 2007.  You’ve got a large percentage of investors buying homes, renovating them, and then renting them to single families.

Another key difference between today and the meltdown we saw during the financial crisis is that borrowers are using traditional products, like a vanilla 30year fixed mortgage. And underwriters are more careful to review the borrower’s credit history, income, and appraised home value.

We are not seeing adjustable-rate loans being written to borrowers with low credit scores. The era of the subprime two-year adjustable-rate loan has long since passed.

So… Will the Housing Market Crash?

It seems pretty unlikely that we are in the same housing bubble seen in 2007-2008.

Although home values in the United States continue to beat the market forecast, home sales remain elevated.

The addition of better underwriting for those interested in buying a home helps the fact that most worthy buyers are living within their means.

If you are looking for a house though and looking for an ok deal, maybe avoid the bay area.

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