Homebuyers have faced a difficult decision during the pandemic: swallow rapid price increases and, or risk being locked out of the real estate market. These dynamics have led some observers to wonder if the US is repeating the early 2000s housing bubble that led to a painful housing crash in 2006 and the Great Recession the following year.
The answer, Dallas Federal Reserve Bank warns, is that the housing market is showing “signs of a brewing US housing bubble.”
That can worry millions of potential homebuyers who are dealing with myriad financial pressure points. First, mortgage interestand averaged 4.67% for a 30-year fixed-term loan in the week ended March 31 — the highest since 2018, according to Freddie Mac. And the national median listing price for a home has risen to a record $405,000, Realtor.com said March 31.
Home buying has skyrocketed during the pandemic due to a confluence of trends. For starters, Millennials now represent the largest US generation and have entered their prime for home buying. And the pandemic has forced millions of people to work from home, prompting some to move away from cities or seek larger apartments to cope with the reality of remote work. The typical listing price for a home has increased nearly 27% over the past two years, Realtor.com said.
Certainly, a rapid rise in home prices doesn’t necessarily signal a bubble, economists at the Dallas Fed noted.
“But real house prices may deviate from market fundamentals if there is widespread belief that today’s robust price increases will continue,” they noted. “When many buyers share this belief, buying for fear of missing out can push up prices and raise expectations of strong home price gains.”
Meanwhile, more and more homebuyers are opting for adjustable rate mortgages, or ARMs, because these loans offer a lower initial interest rate for a few years but then adjust to higher interest rates annually. According to real estate company Inman, demand for ARMs is up 26% year over year. The current interest rate for a 5/1 ARM (with a five-year starting rate) is 3.5%.
To examine whether the current momentum might reflect a bubble, economists at the Dallas Fed examined three different market metrics. Their conclusion: There are signs of a “market tipping point”.
First, economists considered a statistical model that tracks “exuberance,” or when prices rise at an exponential rate that cannot be justified by economic fundamentals. When their exuberance measure hits a 95% threshold, it signals 95% confidence that the market is experiencing “abnormal explosive behavior,” they noted.
The current level of exuberance: 115%.
Next, economists looked at another measure of valuation: comparing home prices to the sum of discounted future rents. It’s a similar concept to how investors determine a stock’s value by looking at discounted future dividends, the economists noted.
This also shows an exuberance that is “comparable to the lead-up to the last real estate boom,” it said.
Third, the analysts examined the ratio of home prices to disposable income, another measure of housing affordability. This has not risen to exuberant levels, but economists noted that household disposable income has been supported by stimulus controls during the pandemic, as well as a drop in household spending due to lockdowns – in other words, temporary factors.
Danielle Hale, chief economist at Realtor.com, said that while current home price growth is unsustainable, it is difficult to predict when price increases will slow.
“Double-digit price increases and rent increases can’t go on forever,” she said.
Hale said rising mortgage rates, which make housing less affordable, should slow the pace of price increases somewhat. “When mortgage rates fell, it helped cushion high housing costs because people had fewer monthly payments. Now interest rates are moving in the opposite direction and monthly expenses are increasing. That means prices can’t keep up the double-digit pace of growth,” she said.
FOMO wave causes concern
There are some differences between 2022 and the housing boom of 2006, which collapsed into a global financial crisis that took years to heal, the economists pointed out.
For one thing, household finances are in better shape than they were in 2006, and the kind of easy credit that fueled this housing boom is a thing of the past. Back then, some banks gave so-called “liar loans,” or mortgages, that required little or no proof of income. Today, banks require buyers to prove their income in order to qualify for a loan.
But there’s something else the economists called worrisome: “A wave of exuberance over fear of missing out, drawing in new investors and more aggressive speculation among existing investors.”
A housing correction fallout from the current housing boom would not compare to the 2007-2009 financial crisis, they said. But for some homeowners, a fix could still prove painful.
CBS News’ Irina Ivanova contributed to the coverage.