Is There a Housing Bubble Brewing?
The start to this year has been anything but smooth for the stock and bond markets. With interest rates on the rise and inflation running amok, some investors have questioned where the bubbles are located. Cryptocurrency and profitless tech companies have already had their bubbles respectively pop. One area some investors have questioned is real estate.
Are we in fact in a major real estate bubble?
A bubble traditionally has 5 stages: Displacement, Boom, Euphoria, Profit-Taking and finally Panic. We have witnessed some displacement over the last 10 years in real estate. The historically low interest rate environment coupled with the low inventory of existing houses on the market are part of the displacement. This has contributed to some of the price change (boom) in existing home sales since the lows after the Great Recession. We have witnessed some euphoric tendencies in the purchases of homes. Above asking price offers were the norm for many markets and sellers enjoyed multiple offers on their house to pick and choose from. In many situations, cash offers were king which alleviates some of the credit risk. In 2021 alone, Redfin ran a study that indicated 30% of new houses were purchased with all cash offers. In 2005-2007, cash offers only made up 21%-23%.
The chart below showcases this run up in existing home sale prices.
US Existing Home Average Sales Price Change
Will the rise in interest rates cause the bubble to “pop?” The next two charts compare US Home Mortgage Liabilities to the prevailing interest rate environment of the time-period.
US Home Mortgages v. 30 Year Mortgage Rate
As I look at both charts, I do not notice a high correlation between interest rates and the willingness to take on added debt to purchase property. The 70s through the 80s had sky high interest rates, but Americans were still willing to add a mortgage on a home as a liability on their respective balance sheets. Lower interest rates do allow for homes to be more “affordable” from an interest rate perspective but it’s not a deal breaker for investors to continue to pursue the American Dream of owning their own home. Higher interest rates do make current prices harder to swallow for first time buyers in this environment, but a complete collapse of the housing market seems unlikely due to rising rates. Lending standards have also increased immensely since the Great Recession.
US Mortgage Originations v. US Existing Home Inventory
Have we entered the profit taking space yet? Judging by the US existing home inventory, demand still outweighs the current supply in the housing market. We can see that new mortgage originations dropped off steeply as the Fed began to discuss raising interest rates. This is a function of the Fed and their tools to combat housing inflation. Couple that with the low inventory, the lending industry has slowed. We may also be witnessing more of a supply and demand re-balance occurring in the housing system.
US Mortgage Originations Refinancing v. 30 Year Mortgage Rate
The re-fi market has also slowed as rates have moved up. The market is seeing fewer people use their home as a “piggy bank” of late. This should not be a concern since the number of re-finances is reverting to a more “normal” level after an abnormally low interest rate period. This is helping to take some liquidity (money) out of the overall market to cool down an overheated economy.
A Look at Mortgage Debt Default and Delinquency
With all the concern about inflation and consumer health, all signs still point to a calm housing market with extremely low delinquency rates on 1st and 2nd mortgages. Granted, someone’s house is the last liability a consumer will default on. I also point to the very low debt servicing levels as a percent to disposable income. This is from extremely low interest rates and many re-finances that occurred over the last 2 years. Homeowners are currently in a strong position.
Mortgage Debt Service as Percent of Disposable Income and Delinquency
Delinquencies can move up quickly during a time of market shock (2006-2008) but this shock was due to overleverage, poor lending standards, and adjustable rate mortgages (ARMs). Adjustable rate mortgages have a lower set interest rate for a fixed period (3/5/7 or 10 years). After that time expires, rates are reset to the market rate. 2/1 ARMs were popular in the early 2000s. Rates rose quickly, consumer’s ARMs expired, and they were left holding an asset they could not sell or pay for due to higher mortgage payments. ARM mortgages are a very small segment in the mortgage pool these days. Consumers were wise to lock in low fixed rates in the 15–30-year ranges. In 2005/2006 35% of new mortgages were ARMs and recently that total has been under 5%. This overall trend to lock in a low rate for longer has allowed for more predictability to the borrower. There has been a slight uptick in new ARMs of late due to the overall cost of homes. It still is nowhere near 2006 levels (under 10% for the last month).
Health of Household Balance Sheets (Assets and Liabilities)
One final note that I would like to touch on is the ratio of total US household assets to liabilities. We can see that the average household balance sheet has been extremely healthy compared to most times in the last 20 years. Homeowners have benefited from a massive gain in equity in their homes and a run up in financial assets (some decrease has occurred with market volatility). Overall, the US consumer has been much more prudent about debt management since the scarring of the Great Recession.
Are there risk factors to real estate? Yes, there always are. However, I would argue that the same risk factors that were associated with the previous real estate bubble do not exist today. Today’s risk is associated with supply and demand constraints. The rise in interest rates should help control the demand side of the equation. If homes stay on the market longer and the outrageous above asking price offers slow, we may see inventory rise back to normal. Balance could be restored to this area of the market. This could cause home prices to moderate or slightly decrease. This will be more dependent on geographical location. It’s hard to expect a significant collapse in the housing market in this environment.