Is American housing heading for another bust?
This question is asked in the wake of the record appreciation of home prices in the United States.
The very followed Case-Shiller Index showed that nationwide house prices were increasing in May by more than 15% per year, the fastest rate in 30 years. According to National Association of Real Estate Agents, the median selling price of existing homes exceeded $ 350,000, which represents an increase of almost 24% in the twelve months ended in May.
Desmond Lachman AEI argues that, adjusted for inflation, US house prices are higher than they were at their 2006 peak. He fears the Federal Reserve is making the same mistake as it did so by keeping interest rates artificially low. Fed actions fueled the housing boom by making credit readily available at very low interest rates.
Lachman is particularly critical of the fact that the Fed continues to buy US Treasuries and Mortgage Backed Securities (MBS) worth $ 120 billion per month as the economy shows signs of overheating. He writes, “In doing so, the Fed not only inflates the US housing market bubble further, but it inflates the global everything bubble as well. ”
My own opinion is that some of the criticisms of Fed policy are valid. However, it is not clear that the surge in house prices constitutes a real estate bubble.
In this regard, it is useful to look at two measures of the affordability of home prices shown in the graph below. The red line is the ratio of the average price of a house to the income based on the average hourly wage. It shows that home prices are today around 7 times high against a historic 5 times average. Using this measure, the housing market looks very expensive for many Americans.
The blue line, for comparison, shows the ratio of monthly payments (based on the cost of financing the average price of a home with the 30-year fixed-rate mortgage in effect) and income. This ratio shows that valuations are in the middle of the range after the global financial crisis (GFC).
The graph illustrates how low mortgage rates have made house prices affordable for Americans despite soaring prices. At the same time, this suggests that they could become less affordable if the Fed increases interest rates significantly. Based on statements from Fed officials, it probably isn’t any time soon. However, the Fed could influence mortgage rates if it slows down its purchases of MBS.
Figure 1. Two measures of housing affordability
One of the main differences from the mid-2000s is that credit standards for mortgages are considerably stricter today. This is evidenced by a shortage of structured products to make homes affordable, such as hook interest rates that start out low but can increase dramatically over time. For the most part, financial institutions have also been more circumspect in ensuring borrowers have the means to repay their debt, although there has been a recent rally in subprime mortgages.
Another important difference is the underlying conditions of housing supply and demand. During the housing boom of the mid-2000s, the existing housing stock was large, peaking at 3.8 million units in 2007. The rapid appreciation in prices was then mainly due to the growing pool of new housing stock. potential buyers as credit conditions eased.
Since then, home inventories have declined steadily and have fallen to just 1.2 million units recently, an all-time low. Under these circumstances, any increase in demand can have a big impact on home prices. This is one of the main reasons potential home buyers get frustrated when they have to enter a bidding war and pay more than the list price to secure a deal.
In short, while the rapid appreciation in home prices in the mid-2000s occurred despite record supply, it is now happening because supply is at an all time high.
Finally, the Covid-19 pandemic has also had a significant influence on the American real estate market: Homeowners have moved from densely populated urban areas to suburbs or locations which are considered more desirable. In April, for example, the annual appreciation of house prices for suburban and less dense cities reached 12% compared to 2% for dense urban areas.
The cities with the fastest home price appreciation are Denver, Phoenix, San Diego, Seattle and Tampa. In comparison, those with the lowest home appreciation are Atlanta, Chicago, Minneapolis, New York and San Francisco.
Nationally, the pandemic has created areas that can be seen as “winners” and “losers” when people migrate. This is similar to the stock market, where industries such as technology and finance have been able to thrive while others, such as travel and leisure, have suffered. That said, almost all geographic areas have experienced some appreciation in home prices over the past year.
Given these considerations, a re-reading of the 2007-2008 real estate crisis seems unlikely. Instead, the more likely outcome is that home price appreciation will slow over time as homes become less affordable and the Fed tightens monetary policy. At that point, some of the fastest rising markets might see some price retracement, but a sustained decline in house prices nationwide is less risky.