Over the last five years (2011 to present) the housing market has seen continual appreciation, rising prices, the return of fix and flip investments, yearly increases in new home construction, which are all signs of a healthy real estate market. In spite of all these key indicators which reflect a healthy real estate market, as Real Estate professionals a question we hear continually asked, “Is there another crash coming?” “Is there another bubble?”
The short answer is no as the current economic indicators show no sign of a current real estate bubble. So let’s examine what those economic indicators are showing us.
What is a bubble?
A bubble or more technically what’s known as an economic bubble, appears when an asset, in this case real estate, begins selling and then continues to sell for more than what would be the expected value of the asset. This is what happened beginning in 2004 when housing prices began skyrocketing overnight and the historically healthy 4-6% annual home appreciation shot to levels in excess of 50%.
What causes a bubble to appear?
There are three factors we will examine in the formation of the previous real estate bubble. While these factors do not comprise an exhaustive list, they are still strong measures to be considered.
First, and most obvious is the ability to obtain financing. The more freely a buyer is able to obtain financing to purchase a home, the more money will enter into the housing market. This in turn creates more demand for homes to buy and Sellers begin selling. With more money in the housing market Sellers begin asking for higher prices, and Buyers will pay it because obtaining the money is not difficult.
Note that this is not the same as “low interest rates,” as the interest rate is more of an indicator of a Buyer’s affordability than it is their ability to actually obtain financing. In fact, interest rates are a factor in the larger scope of a Buyer’s ability to obtain financing.
Anybody could by a house when underwriter guidelines were loose with stated income loans (no verification of income needed), sub-prime loans (high potential of default due to poor debt to income ratios), and interest only loans. These programs all meant the affordability of a home was open to almost everyone because obtaining the financing was so easy.
Second, housing prices rising faster than the norm. A rise in prices or appreciation of 4-6% with no other economic factor outside the housing market being present to merit the rising appreciation should be concerning.
Home values typically rise as a result of a strong or stable economy in which unemployment is low, wages are stable and rising, and the gross domestic product (GDP) is healthy. The stronger these areas the more appreciation you can have and it will be stable. However, when you have increasing home values for no other reason than supply and demand you can get double digit appreciation and inflated values.
Third, reckless disregard for the Buyer’s affordability in purchasing the home. When prices are rising quickly, and the ability to obtain financing is easy, the fear that someone may not be able to afford the monthly payment of the home is mitigated by the gamble the home will increase in value enough to payback all the debts should the Buyer be unable to make their payments.
These three factors were present in the early 2000s culminating in the skyrocketing prices of 2004-2007, which ultimately preceded the crash of the real estate market from 2008-20011.
While there is no question as to the rise and fall of the housing market, the question for many consumers still remains as to whether we are now seeing the formation of a new bubble, as the housing market continues to recover each year since 2012.
Bubble in 2015 and Beyond?
Many view the housing recovery to have begun in 2012, and on some levels it has been a quick and speedy recovery when considering as of 2011, home prices were down in the hardest hit locations such as Arizona, Nevada, and Florida, by as much as 60%. Over the next two years from 2012-2013 these same areas were experiencing appreciation of an astounding 20%-30% (outlying areas saw as high as 50%). Through 2014, however, things settled down and appreciation was more in the 10% and in 2015 it has remained around 4-6%.
It is important to note here that even with as much as 30% appreciation in a single year, values had fallen by as much as 60% meaning a home worth $300,000 around 2007, before the crash, had a value of $120,000 in 2011 and may have been worth only $156,000 by the start of 2013 and $202,800 by 2014.
Some look at the housing market and note that appreciation of 30% is not sustainable, nor is it healthy, and that anything beyond 4-6% appreciation should be regarded with great concern. While this is indeed true, the facts of the situation must also be examined.
When looking at the facts we see the historical trend of 4-6% appreciation for decades which has historically made real estate one of the more reliable investment options. If you were to take the home values at the beginning of 2003 before the run up of the market, and apply an appreciation rate of 4-6% over the next 13 years, a home worth $100,000 in 2003 would have a value of $213,294 in 2015. Interestingly enough, what we find is that homes today are in line with this appreciation scale, meaning had the spike and crash of the housing market not happened and we continued on with 4-6% appreciation for the intervening years, housing prices today are right in line with where they would have been predicted to be in 2003.
All this being said it does not mean value won’t come down, nor that they won’t go up. It does mean that value changes outside the norm, whether it is up or down, won’t be due to a housing bubble, but rather it will be the result of some other economic event such as hyperinflation, a collapse in the currency, effects of global markets, etc. For this reason affordability is becoming the focus.
The recovery of the housing market has been marked by laws and regulations aimed at the factors noted above. Primarily underwriting guidelines have become exponentially more stringent and much emphasis is being placed on the affordability of the loan rather than on the property’s future value. Buyers must now prove they have the ability to pay back the loan through employment and income verification, asset verification, and more stringent requirements placed on debt/income ratios.
This shift to affordability, in the long term, should ensure a homeowner is able to stay in their home even in the face of real estate market shifts. Even through the downturn, those who were able to afford their payments were never forced to sell, and now they are seeing their home values return.
With home value stabilizing and no bubble existing in the housing market, now is the time to sit with a real estate professional who understands the history of the market, the current conditions in the market, and is proactively engaged in interpreting our local real estate market trends.
Your TEAM of Real Estate Professionals at WELLS Realty Group pride themselves on understanding the housing market, understanding your situation, and providing custom solutions to meet your real estate needs. Whether you are thinking of buying, selling, or investing, contact WELLS Realty Group.