Signs of a Housing Bubble are Brewing

All across Virginia - like the rest of the USA - most residential real estate markets are seeing surging home prices thanks to low inventory, increased constrution costs, and historically low mortgage rates.  My law practice has focused largely on real estate, both residential and commercial, since 1983. I have never been busier and throughout the pandemic, the law firm never closed down and the number of closings has been very high with the only slow down being in January and early February due to fewer purchase contracts being signed during the holiday season - it takes 30 to 45 days typically from contract signing to closing - which has long been the case.  In my own neighborhood, recent sales continue to see higher and higher prices and the reassessed value of our home (up 47% in part due to the extensive rehab work we have done) is likely already under true market value based on the most recent sales.  With mortgage rates having crept up some, perhaps the market price surge will slow, but some worry that a housing bubble may be on the way as laid out in a piece at CNN.  One can only hope the concerns prove wrong and that better mortgage underwriting will avoid a reprise of 2007-2008.  Here are article excerpts:

US home prices have soared to new heights and they keep on climbing, and some researchers and economists say they have seen signs of a housing bubble brewing.

Home prices are rising faster than market forces would indicate they should and are becoming "unhinged from fundamentals," according to a new blog post written by researchers and economists at the Federal Reserve Bank of Dallas. 

Until recently, the possibility of a bubble wasn't widely supported. But after looking at housing markets across the US, the Fed researchers said new evidence is emerging. 

"Our evidence points to abnormal US housing market behavior for the first time since the boom of the early 2000s," the researchers wrote. "Reasons for concern are clear in certain economic indicators ... which show signs that 2021 house prices appear increasingly out of step with fundamentals." 

Many Americans are still scarred by the last housing crash in 2007, which was fueled by cheap credit and lax lending standards that resulted in millions of homeowners owing more on their homes than they were worth. 

But this time, the economists said they are worried about a different scenario. 

Just because home prices are rising wildly does not always mean housing is in a bubble. And there are lots of reasons why home prices have risen steadily over the past decade and shot up even more significantly in the past two years, including supply and demand imbalances in the market, rising labor and construction costs and how high or low the interest rates are for a mortgage, the researchers pointed out. 

But they said prices may be rising to a point they call "exuberance," in which prices become increasingly out of sync with the economic fundamentals underpinning the market. 

One possible reason, they suggested, is that buyers may believe prices will continue to climb and fear they will miss out on snagging a lower price on a home now and get stuck paying more later.

This fear of missing out, or FOMO, effect can drive up prices and heighten expectations of higher prices ahead. That can create a self-fulfilling prophecy, researchers said, in which price growth can become exponential. 

The consequences of housing market exuberance can include overpriced homes, investments based on distorted expectations of returns and reduced economic growth and employment. 

The cycle is interrupted when policymakers intervene, spurring investors to become cautious and causing the flow of money into housing to dry up. This could cause a housing correction or possibly even a bust, according to the blog post. 

The researchers recommended policy makers and market participants closely watch local markets for booms in prices in order to better respond, "before misalignments become so severe that subsequent corrections produce economic upheaval." 

The behavior of homebuyers and sellers over the past two years has been anything but normal, the researchers pointed out. Prices are at record highs and continue to move higher because there has been record low inventory. Still, homebuyers keep buying. Interest rates fell to record lows during the pandemic, but that does not alone explain the housing market frenzy, they wrote. 

Fed researchers also looked at the relationship between home prices and rents. They found that since 2020, the home price-to-rent ratio has rapidly skyrocketed beyond what market fundamentals can explain and began showing signs of exuberance in 2021. 

Another indicator the researchers examined was the ratio of home prices to disposable income, which is closely tied to affordability. This home price-to-income ratio is increasing quickly, but not yet exuberant, the researchers said. 

A lot was learned from the last housing crash, which has led to better early detection and warning indicators of housing bubbles, the researchers wrote. If these concerning trends continue, banks, policymakers and regulators ought to be better equipped to quickly react to avoid the most severe, negative consequences of a correction. 

In addition, they wrote, there is no reason to expect any resulting correction would impact homeowners or the economy as significantly as the last housing crash. Americans are generally in better financial shape, homeowners have stronger equity positions and excessive borrowing is not as rampant as it was in the mid-2000s.