Where Are We Now? 5 Traits of a Real Estate Bubble

I'm in Colorado for the next couple weeks and have had some time to reflect on things a bit.

Let's revisit a post I made in more detail to help us be more objective about the possibility of real estate being in a bubble:

Most people see one headline or a few sales in their area and say "I can't believe how expensive houses have gotten. We're for sure in a bubble." 😱

Rather than using our gut (which is usually wrong when it comes to financial markets), we need to gather data on the topic.

The hardest part is figuring out how to measure each of these bubble characteristics.

The good news is I've got 5 charts to help us with actual data on the topic!

And away we go! 🚀

🫧 Bubble Trait #1: People are over-borrowing to buy properties.

Above is a chart from the Philadelphia Federal Reserve which tracks the average loan-to-value (LTV) of single family mortgages.

💡 The higher the number, the more risky the loans because homebuyers are putting less money down (LTV of 95% means there was a 5% down payment). 

We got in trouble in 2008 because people were borrowing 100%+ of the value of the properties in order to keep buying.

The lenders stopped offering easy money and everything came crashing down. 💥

Looking at the recent data, we can see that LTVs on new mortgages are near the high amounts in 2018, but not worse. 😅

Comparing to 2008, the data is a little muddy. LTVs didn't get out of hand on purchases back then, but we have to remember that the realtor, lender, and appraiser could all be the same person and appraisals were getting inflated (making LTVs appear lower). 

Also, most people pulled out 2nd loans further increasing the total LTV and risk.

There's not widely available data on this to help us compare to back then, but homeowners have a record amount of equity which suggests we don't have the 2008 issue of people using their homes as ATMs. 👍

🫧 Bubble Trait #2: Property prices are skyrocketing beyond incomes.

The national payment-to-income ratio is the share of median income needed to make the monthly principal and interest payment on the purchase of the average-priced home using a 20% down 30-year fixed rate mortgage at the prevailing interest rate 

This is one of the main points put forth by those arguing we're in a bubble about to pop.

They're correct that these numbers are signaling that buying a home has gotten more expensive. 😬

The one thing that can get lost in these numbers is that people's income usually has a lag in getting updated while home prices and interest rates are refreshed in real time.

Plus, there's a significant amount of relocation throughout the country and continued prevalence of remote work. 📦

Because of this, I think incomes are moving faster than people can measure.

Are homes expensive right now? Yes.

But.. people are qualifying for mortgages that aren't easy to get and many are paying cash which signals that incomes are keeping up relatively well - especially in certain local markets (like Jacksonville). 😲

🫧 Bubble Trait #3: Flippers are snapping up homes for quick profits. 

ATTOM analyzes sales deed data to measure flips.

For reference, they define a flip as any arms-length transaction that occurred in the quarter where a previous arms-length transaction on the same property had occurred within the last 12 months.

You can see just how prevalent flipping was ahead of the 2008 crash and again in 2021/2022. 👀

It's easy to assume we're on the same path, but when you compare the inventory on the markets then to now, you'll see the markets are drastically different.

Back then, flipping was keeping the markets going as so many people were speculating that prices would keep rising.

When it stopped, so did the markets.

Today, everyone's locked into ultra-low rates and will fight tooth and nail to keep them. 👊

This is keeping inventory in check and limiting the chance of a 2008 repeat. 

🫧 Bubble Trait #4: Everyone believes prices will only climb.

The NAHB/Wells Fargo Housing Market Index (HMI) is designed to gauge and track the pulse of the single-family housing market from a builder's perspective.

This chart is focused on the expected sales of single-family homes for the next six months according to home builders across the country.

Higher means more optimism and lower means builders are pessimistic about the future. ⚖️

After making all-time highs in 2020, we've come back down to a modest reading of 54 indicating modest optimism for the future.

This shows that not everyone is seeing rainbows and sunshine in the housing market. 😨

The number of people calling for a crash should be encouraging to those worried. Bubbles truly hit their peak when everyone thinks things will stay this good forever and we're certainly not at that point.

🫧 Bubble Trait #5: Banks are lending to everyone.

Lastly, we have lending standards to consider.

The Fed surveys senior loan officers around the country to keep track of when banks are making it harder for people to get loans (tightening) and when they are lending more freely (loosening). 🏦

A positive number on the chart means tightening and a negative number means loosening.

Since 2022, standards have been rising and only recently begun to fall.

It's clear that getting a loan still is a process and banks aren't handing them out like candy like they were prior to 2008. 🍬

Finding Opportunity

Overall, I can say without a doubt that the market isn't perfect.

There will always be challenges in the market and nobody can predict the future. 🔮

But, as we consider the various characteristics of a housing bubble, I feel confident that we don't check all the boxes.

This can vary by location and you should think about how your local market lines up. 🤔

I look at these measures and actually see a market that has been through the hard times and is ripe for a rebound.

Owners have a lot of equity, people are still paying their mortgages on-time, lending standards are starting to loosen a little, optimism is relatively low, and flippers are becoming less common.

A contrarian would suggest this might actually be the bottom. 🤷‍♂️

Further, we're a 1% decline in interest rates away from a tsunami of transactions.

Most savvy investors would tell you to invest when people are fearful and hold off when they're greedy.

This feels like the first scenario to me. Does it to you? 🤨

Dr. Alex Stewart
Founder

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