Wednesday, April 04, 2018 / by Joseph Moncada
There are plenty of signs that the housing market is heading into trouble.
One sign of an asset bubble is that home prices have escalated. National median family home prices are 32% higher than inflation. That's similar to 2005, when they were 35% overvalued.
The Housing Bellwether Barometer is an index of homebuilders and mortgage companies. In 2017, it skyrocketed like it did in 2004 and 2005. That's according to its creator, Stack Financial Management, who used it to predict the 2008 financial crisis. Similarly, the SPDR S&P Homebuilders ETF has risen 400 percent since March 2009. It outperformed the S&P 500 rise of 270 percent.
Home prices in Denver, Houston, Miami, and Washington, D.C. are at least 10 percent higher than sustainable levels, according to CoreLogic.
In 2016, 5.7 percent of all home sales were bought for quick resale. These "flip" homes are renovated and sold in less than a year.
The 2008 Housing Market Crash
People who were caught in the 2008 crash are spooked that a 2017 bubble will lead to another crash. But it was caused by forces that are no longer present. Credit default swaps insured derivatives such as mortgage-backed securities. Hedge fund managers created a huge demand for these supposedly risk-free securities.
That created demand for the mortgages that backed them.
As many unqualified buyers entered the market, demand soared. Many people bought homes as investments to sell as prices kept rising.
In 2006, homebuilders finally caught up with demand. When supply outpaced demand, housing prices started to fall. That burst the asset bubble.
The ticking time bomb was the millions of interest-only loans. These allowed borrowers to get lower monthly payments. But these mortgage rates reset at a higher level after three years. Many of these homeowners could not pay the mortgage. Then housing prices fell and they couldn't sell their homes for a profit. As a result, they defaulted.
Nine Reasons Why a Housing Crash Isn't Imminent
- There are many differences between the housing market in 2005 and the current market. In 2005, subprime loans totaled more than $620 billion and made up 20 percent of the mortgage market. In 2015, they totaled $56 billion and comprised 5 percent of the market.
- Banks have raised lending standards. According to CoreLogic’s Housing Credit Index, loans originated in 2016 were among the highest quality originated in the last 15 years. In October 2009, the average FICO score was 686, according to Fair Isaac. In 2001, the average score was 490-510.
- Tighter lending standards has made a difference in the "flip" market. Lenders only finance 55 percent of the home's value. The "flipper" has to come up with the rest. During the subprime crisis, banks lent 80 percent or more.
- The number of homes sold today is 20 percent below the pre-crash peak. That means there's only a four-month supply of homes available for sale. As a result, about 64 percent of Americans own their own homes, compared with 68 percent in 2007.
- Home sales are lower because the recession clobbered young people's ability to start a career and buy homes. Faced with a poor job market, many furthered their education. As a result, they are now burdened with school loans. That makes it less likely they can save enough to buy a home. That will keep demand down.
- Home prices have outpaced income. The average income-to-housing cost ratio is 30 percent. In some metro areas, it's skyrocketed to 40 or 50 percent. Unfortunately, metro areas are also where the jobs are. That forces young people to pay more for rent to be close to a job that doesn't pay enough to buy a house. Thirty-two percent of home sales today are going to first time homebuyers, compared to 40 percent historically, says the NAR. Typically, this buyer is 32, earns $72,000 and pays $182,500 for a home. A two-income couple pays $208,500, on average.
- Homeowners are not taking as much equity out of their homes. Home equity rose to $85 billion in 2006. It collapsed to less than $10 billion in 2010, and remained there until 2015. By 2017, it had only risen to $14 billion. Obamacare is one reason for that. Bankruptcy filings have fallen 50 percent since the ACA was passed. In 2010, 1.5 million people filed. In 2016, only 770,846 did.
- Some people point that national housing prices have exceeded their 2006 peak. But once they are adjusted for 11 years of inflation, they are only at the 2004 level. Between 2012 and 2017, home prices have risen 6.5 percent a year on average. Between 2002 and 2006, they rose 7.5 percent annually. In 2005, they skyrocketed 16 percent.
- Homebuilders focus on high end homes. New homes are larger and more expensive. The average size of a new single family home is almost 2,700 square feet. That compares to 2,500 square feet in 2006.
Higher interest rates have caused a collapse in the past. That's because they make loans more expensive. That slows home building, decreasing supply. But it also slows lending, which cuts back on demand. Overall, a slow and steady interest rate increase won't create a catastrophe.
Will House Prices Fall?
In the last housing bubble, homebuilders submitted permits for new construction. That was less than 1 million in 1990 during the recession. It gradually rose throughout the 1990s, exceeding 1 million in 1998. It remained at that level until 2002, when it surpassed 1.5 million. It hit a new record of 2 million in 2004 and 2005. In 2006, housing prices began falling. Homebuilders sought more than 1.5 million permits. That fell to less than 1 million in 2007. By 2009, it had collapsed to 500,000.
They've only gradually recovered to 1.3 million in 2017. They are expected to drift lower, to 1.1 million by 2020.
When Will the Housing Market Crash Again?
The next market crash will occur in 2026, according to Harvard Extension School professor Teo Nicholas. He bases that on a study by economist Homer Hoyt. Real estate booms-and-busts have followed an 18-year cycle since 1800. The only exceptions were World War II and stagflation.
Nicholas says the 2017 real estate market is still in the expansion phase. The next phase, hypersupply, won't occur until rental vacancy rates begin to increase. If that occurs while the Fed raises interest rates, it could cause a crash.
How to Protect Yourself From a Crash
If you're among the majority of Americans who are worried, then there are seven things you can do to protect yourself from a real estate crash.
- Buy a house to live in, not to flip. Two-thirds of the homes lost in the financial crisis were second and third homes. When the sale price dropped below the mortgage, the owners walked away. They kept their homes, but lost their investments.
- Get a fixed-rate mortgage. As mortgage rates rise, your payment will stay the same. If this means you can only afford a smaller home, so be it. That's better than taking a risk and losing it later on.
- If you get a variable rate mortgage, find out what the interest rate will be when it resets. Calculate the monthly payment and make sure you can afford to pay it with your current income. Take the difference between that future payment and what you are paying today with the lower interest rate and save it. That way you will have the funds to pay your mortgage if your income falls.
- Buy the worst house in the best area you can afford. Make sure the area has good schools, even if you don't plan on having children yourself. Potential buyers will. You can always improve the house over the years if your income permits. Good neighborhoods aren't going to suffer as much in the next downturn as poorer areas. They will also bounce back quicker.
- Make sure your house has at least three bedrooms. That will attract families if you need to resell.
- The best way to protect yourself is with a well-diversified portfolio of assets. Diversification means a balanced mix of stocks, bonds, commodities and equity in your home. Most financial planners don't include home equity as an asset, but they should. It's the biggest asset most people own.
- To limit the damage of a real estate collapse, buy the smallest home you can reasonably live in. Try to pay off your mortgage early, so you don't lose your home in a downturn. Boost your investments in stocks, bonds, and commodities so they equal or exceed your home equity. If there is an asset bubble in housing, don't succumb to the temptation to refinance and take out the equity. Instead, revisit your asset allocation to make sure that it is still balanced.