A lot of people think we are due for another housing market crash because housing prices have skyrocketed. Besides prices, there are many things that drive the housing market. In fact, prices cannot be used as an indicator of what the market will do because they are just a result of supply and demand.
Supply is affected by foreclosures, homeowners’ willingness to move, new construction, and many other factors. Demand is driven by the economy, lending guidelines, potential homeowners confidence, wages, and much more. I believe the supply and demand affecting today’s’ housing market is much different than what drove the last housing boom. While prices could level out or decrease in some areas, I do not think we are in for a nationwide crash.
Many people believe because of the increase in home values over the recent years that a crash is imminent.
“Just look at what happened in the mid to late 2000s. Prices are so crazy now that a crash has to come soon!”
The first thing you have to realize is that the last crash was the worst crash we have ever had. Those crashes do not happen over and over again. An increase in prices does not mean a crash is coming. Prices can increase or decrease, but that is what happens in a healthy market. A crash is much different from a down market.
How likely is another crash?
When some investors think of real estate, they assume that because prices are generally rising across the country, we must be headed toward another crash. The truth is that’s simply not the case. A bevy of factors have come together that are serving to safeguard the economy against another national crash. We could see prices slow down, or decrease some, but a crash is unlikely. Increasing prices is not the only reason a crash must come. Other countries and the US have seen price booms in the past without a crash.
The last crash was the biggest in recent memory and if you look at the data further back it is the same with small adjustments. A lot of people will also tell you we have a housing crash or recession every 10 years. If you average them out we have recessions every 18 years, but not always true for the housing market. The dot com recession did not affect housing much at all. Some times we have a recession 5 years after the last one and sometimes we have it 25 years after the last one. Even if we did have a recession every 18 years we have a long time to wait since the last recession ten years ago.
Are loans getting easier to get again?
In 2005, subprime loans were rampant and as a result, the country over-leveraged itself. Subprime loans, the riskiest loan type given to borrowers with low credit scores, totaled more than $620 billion. Fast forward ten years and subprime originations make up only 5 percent of the mortgage market and add up to $56 billion. Compare that to 2005 when subprime origination made up 20 percent of the market. This represents a 91 percent decline from the height of bad loans that set up the economic crash.
Source: Inside Mortgage Finance; Equifax
Not only has subprime lending seen a major decline, but mortgages have also become much harder to attain due to stringent lending standards. According to CoreLogic’s Housing Credit Index, loans originated in 2016 were among the highest quality originated in the last 15 years. This is greatly due to the type of borrowers able to qualify for loans. The current average credit score for borrowers being granted mortgages is 739. In October 2009, the average FICO score was 686, according to Fair Isaac. The lowest one percent of mortgages issued have credit scores averaging 622-624. Compared to the average range in 2001 of 490-510, the standard to get financing has risen substantially, and as a result, the likelihood of default has dropped. Lenders have done this to ensure the economy doesn’t again become propped on bad loans like it was leading up to the Great Recession.
The difficulty in getting a mortgage combined with extremely high student debt strapping down the millennial generation continues to nudge people toward renting. Americans don’t have the savings they used to have that allowed them to put a down payment on a home. Historically, the average savings rate of a person’s income was 8.3 percent, but today that number is 5.5 percent. Rising education and housing costs continue to burden the new generation of potential home buyers, driving down homeownership rates in the U.S.
Source: Federal Reserve Bank
Interest rates are another important factor to consider. The Fed has only raised interest rates one half of a percent, but actual mortgage rates have come back down. That said, rates could eventually rise, so it’s wise for investors to prepare a strategy for when that occurs as it can impact their ability to finance an investment portfolio.
Is the United States housing market unaffordable?
The affordability index continues to be stacked against potential home buyers. As housing and rental prices steadily increase, wages continue to stay relatively stagnant. Historically, the average income-to-housing cost ratio in the U.S. has hovered near 30 percent, but in some metro areas, that number is currently closer to 40 and even 50 percent! This strips away the opportunity to save money as a significant portion of a person’s monthly income is going to keeping a roof over their head.
Source: U.S. Census Bureau
However, the United States is still much more affordable than in many other countries. Many of those countries have not seen a huge crash. People tend to find ways to buy homes, even when they are very expensive. Affordability in itself will not cause a crash. Although, it could cause a slowdown.
Is supply or demand at fault?
Housing supply is also an important dynamic to consider when looking at a then-and-now analysis of the housing market. Since mortgages were being given out with little regard to the borrower’s ability to pay back the loan, new home building skyrocketed to meet the new demand. In 2005, new home sales hit a 52 year high with 1.28 million new homes being built. Ten years later, only 500,000 new homes were constructed, dropping 61 percent from the peak ten years prior. An overall lack of inventory continues to be a driver in price appreciation.
Source: U.S. Census Bureau
While there are risks for local bubbles in markets experiencing inorganic growth, like the Miami condo market, for example, it’s wise for investors to focus more on their own investment strategy and less on speculation of the overall market. If able to identify and clearly understand a market and its economy, investors can find success with single-family investments.
The biggest factor causing the housing market increase in Albany today is low inventory. The last crash was caused by horrible lending guidelines and overbuilding. We will continue to have low inventory until building picks up, and it simply has not happened here. While we see new developments sprouting up around the capital region, it still isn’t changing a primary driver for us.. First time home buyers and affordability In Albany. We have seen a large increase in prices on 2-4 family homes locally. This is due to affordability.. Buyers have better buying power when looking at 2-4 families due to the supplemental rents that most banks view as additional income for the borrower.
When can we expect another decline?
The housing market will not grow forever, but it is hard to say when things will change. Real estate trends are very different in various parts of the country. Some parts of the country may see increasing prices for a few more years, while others may see a drop right away. In Albany I could see prices steadying out due to the affordability problems in some areas, especially if interest rates rise. Those two factors will not cause a crash when so few homes are being built and the quality of new loans is so high.
It’s likely that our market here will normalize in the near future. I.e. Prices plateauing for a bit.. maybe even decline for a moment but the truth of the matter is it wouldn’t be much and if it did it wouldn’t take long to correct. Many investors have been “saving” in preparation for a market decline or correction. They feel they simply can’t find good enough deals currently so they’re stockpiling cash to invest when the prices go down. This goes for local and foreign investors. So should our market take a dip we would still see very high buyer demand in the market which inevitably drives housing prices back up!