The Hot Housing Market
Introduction
The housing market has been hot. Maybe too hot? When I polled my economics friends, most of them did not think that we have a housing bubble. When I polled my real estate friends, they also said they did not think that there is a bubble. However, I believe that there is a bubble and today I am going to explain what is happening and why I disagree with my economics and real estate friends. Disclaimer : I do not think that there will be a housing crash. I believe that there will be a market correction.
Feeling the Heat
The housing market has been on an upward trend since it found its bottom of the first quarter of 2009. At that time the median house sold for $208,000. In the fourth quarter of 2020, the median house price in the U.S. was $346,000.
When you look at the last two years, you notice that the increase in median house prices is steeper than the last year, and I expect that the first quarter of 2021 would continue this trend.
The increasing home prices in the U.S. if part of an international trend. House prices in developed economies have been increasing drastically.
The question to ask now is why? Is this growth sustainable or is it a sign of an overheating housing market that will eventually correct by having prices fall?
It is not easy to answer that and it requires some detailed analysis. My position is that prices will have to correct, but first let’s discuss why there was the sudden increase in home prices.
Low Interest Rates
The Federal Funds Rate has been decreasing since 2019, and the target rate decreasing to 0-0.25% when the pandemic hit. With the low Federal Funds Rate, the long-term rates, rates on 30 year mortgages to fall to as low as 2.6% at the end of 2020. Having low interest rates makes home buying less expensive, debt is cheaper. Low interest rates also means that people shift from saving money to spending their money, since it no longer earns interest. With these two situations combined, housing prices increase because there is a higher demand.
30 year mortgage rates over the past few years
The Housing Supply
With a growing demand for buying houses, the supply of houses is at it lowest since the 1990’s. Home building has lagged since the Great Recession of 2007-2009 and with the sharp spike in demand, home builders have not been able to increase the home supply. While building has increased in activity, labor shortage and higher material costs are limiting builders from increasing the housing supply.
The Relocating Homeowner
Say you want to buy a home in your hometown. You may be facing competition from some one from California or New York. With Covid-19, remote work is much more common and people are taking advantage of it to move to different states. Homeowners are no longer tied down to a commute to an office and want to take advantage of that by moving somewhere else. There are many reasons to move, including lower home prices or better weather. Relocation is causing housing markets that usually are much lower than places out in California or in New York, increase in prices. These relocations can ruin the housing market for the locals.
Some states are also incentivizing people to move to their state. West Virginia is paying $12,000 for remote workers to move to the state. Other places that have offered remote workers cash to relocate are Akansas and Nevada.
Speculation
$77 billion worth of homes are being purchased by investors. This is similar to the housing boom of 2007 when speculators pushed housing prices up. However my economist friends say not to worry about this behavior because the purchasing is not fueled by debt.
Irrational Exuberance
Purchasing behavior today has the potential of having house prices not reflecting their true value. This does not follow the traditional real estate patterns. Normally when you purchase a home, the process involves an inspection and an appraisal. This gives the buyer and mortgage underwriter more information about the true value of the home. The inspection ensures a quality house and the appraisal determines the market value.
In today’s market, we are seeing offers that waive the inspection and appraisals which can lead to disconnect between purchase price and market value. Other times there are instances when the appraisal does not match the purchase price. In the past, the purchase price would be renegotiated to or much nearer the market value. Today, the buyers are making up the differences.
This tells me that home buyers are buying more for homes than the appraised value and is causing the acceleration of home prices. Alan Greenspan coined a phrase irrational exuberance. This refers to the investor enthusiasm that drives asset prices higher than those asset fundamentals justify.
That is what is occurring in the housing market today. Remember, I don’t expect a crash but I do think that there are some cracks in the fundamentals and the behavior in the housing market do not make sense.