Home prices have skyrocketed during the pandemic, leading many to believe that we are either in a real estate bubble or we are heading towards a real estate bubble.
The good news, however, is that the United States is not about to repeat the 2005-07 housing boom and recession that led to the Great Recession. The basic factors of supply and demand – not speculation, predatory loans and / or bad underwriting – drive up house prices. In addition, a series of protections in the mortgage market should prevent a hard landing when house prices fall.
Prices for existing homes rose 23.4% in June from a year ago, according to the National Association of Realtors. This price spike reflects a confluence of pandemic-induced events and demographic factors, which have driven demand for housing, after more than 15 years of underinvestment in housing.
Demand for housing increased during the pandemic as the Federal Reserve cut interest rates to zero, bringing mortgage rates to record highs. Freddie Mac’s 30-year fixed mortgage rate hit an all-time low of 2.65% in January and remains historically low at around 2.8%.
The wave of Americans suddenly working from home during the pandemic added to demand. Many were looking for larger spaces with home offices and other amenities, dramatically increasing the demand for new and existing homes. It also happened when older Millennials hit the old age (30-40) when buying a home becomes attractive and many are starting families and saving.
This combination of factors drove household formations (e.g. moving to a new house or apartment away from parents or roommates) to a total of 4.95 million over 12 rolling months in mid-2020, up from around 1.5 million households formed over a rolling 12-month period. based on the previous year – a record high that we estimate using Census Bureau data.
The available housing, meanwhile, was woefully insufficient for the growing demand.
It is a shortfall that is long overdue. The decade following the housing boom and recession of 2005-07 saw chronic underinvestment in housing, resulting in anemic growth in inventories. The brief increase in the costs of building materials (wood and copper, for example) this year has also dampened attempts to increase inventories, pushing up house prices.
In 2019, there were an average of 889,000 single-family home openings per month, according to the Census Bureau. In 2021, that figure was 1,130,000 per month on average. That’s a welcome increase given the low inventory, but 2021 levels are pale from the pre-bubble peak of 1,823,000 in January 2006. The number of existing homes for resale in June – 1.25 million – was about a third of that of 2007 peak of 4.04 million.
It’s no surprise that skyrocketing demand and tight supply have pushed up home prices. Indeed, according to Redfin, residences that had been on the market for about 44 days before the pandemic were recovered in as little as 15 days in July of this year.
Still, a possible slowdown in home prices is unlikely to trigger another Great Recession-type event, as financially healthy homebuyers and mortgage market safeguards should help prevent one.
Most new mortgages are fixed rate, as opposed to the riskier variable rate mortgages that were more prevalent in the mid-2000s. In addition, most new buyers have higher credit scores and higher incomes. borrowers at risk from the housing bubble.
These factors suggest less risk for homeowners and the housing market in general if the Fed raises interest rates. Individuals and the market are better placed to face the vagaries of the road.
Additionally, deposit-taking institutions (i.e. banks and credit unions) and government-sponsored companies, or GSEs, like Fannie Mae and Freddie Mac, hold most mortgage debt. This change occurred as a result of the Dodd-Frank Act of 2010. Banks and credit unions are heavily regulated and need to have strong capital structures to mitigate risk. These factors suggest limited risk in the financial markets in the event of a fall in prices, as these institutions are unlikely to crack under financial stress.
A large portion of mortgage loans are held by mortgage real estate investment trusts (REITs). Although regulated by the Securities and Exchange Commission, REITs are not backed by the entity. However, the Fed can step in and deploy quantitative easing to help ease pressures in the REIT market with purchases of mortgage-backed securities to provide liquidity.
So, we should not be afraid that this hot real estate market will collapse and cause great economic hardship. This time around, the market is on a stronger foundation than the fragile bubble that grew and burst in the mid-2000s.
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