This is why a real estate boom is not a bubble

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By all available estimates, average home sales prices in the United States are at an all-time high with little sign of decline.

For some, this brings up memories of the real estate fiasco of the 2000s, and they wonder if this bull market will end, as it did then, in a big crash. The good news: Today’s strong housing market is radically different, much healthier, and could take many years to come.

Back in the mid-2000s, after the systematic deregulation of financial regulation, the real estate market rallied for all the wrong reasons: undocumented mortgages (those that were approved without checking the borrower’s financial condition), the appraisal industry went awry – for AAA credit ratings for derivative products secured by inferior mortgage loans. The real estate boom was built on fragile foundations and collapsed accordingly. The ensuing crisis was severe.

Very little of this is happening today. Banks have adopted (or forced them to apply) much stricter lending standards, resulting in the lowest ratio of real estate loans to total loans for commercial banks since the 1980s.

Since boom and bust real estate crises are most often associated with credit bubbles, declining real estate lending suggests that speculation is not the driving force behind today’s bullish residential real estate market. Rather, it is a consequence of an imbalance between supply and demand that has been created over the years.

The builders were hit hard by the real estate crisis and it took them a long time to get back on their feet and resume normal operations. As a result, the supply of new apartments lagged significantly behind the growing demand for demand, arising simply due to the increase in the number of households.

This imbalance between supply and demand grew largely imperceptibly for two reasons. First, it took consumers a while to rebuild their own finances before they were ready to buy homes. Another related reason is that the number of new households itself declined after the crisis, as is often the case after a recession.

In fact, according to the U.S. Census Bureau, there were fewer households in 2020 than in 2019 – for the first time in history that number has declined from year to year. This is due to the unique characteristics of the 2020 recession (restrictions were imposed, forcing some to consolidate dwellings), and it created the conditions for the sharp drop in demand for new homes taking place today.

Thanks to stimulus packages and cost cuts during the pandemic, the savings rate also rose to its highest level since the pandemic, setting the stage for a surge in new households this year and possibly next. This will contribute to a housing shortage, prolonging the conditions of high demand.

Remarkably, homes are becoming the most affordable for more than one generation. Mortgage payments for the average U.S. home have not been as low as a percentage of household income since at least 1984, when the household income series began, and probably for several decades before. Mortgage rates (or house prices) would have to roughly double for this percentage to rise from less than a quarter of household income, as it is today, to about one-third where it was a decade before the pandemic. Moreover, it is based on the overall average US home price. Given that mortgages typically cover 70% of the purchase price, the availability of monthly payments could be even higher, at least without considering the required upfront payment.

The takeaway is that despite the notable rises in property prices and the drought in housing inventory reported by realtors everywhere, there seems to be no sign of a real estate bubble. With affordable and scarce homes, it might seem that prices may have significantly more upside potential before they can be considered expensive, all other things being equal (mortgage rates, family income). It can take years to close the lag in housing commissioning, especially if construction activity slows down in response to higher building materials costs earlier this year.

One caveat is that this analysis applies to the vast middle segment of American consumers, but the highs and lows require different considerations.

At the top of the spectrum, luxury home sales and prices have risen more than mid-priced homes. Recent report real estate agency Redfin.

Measuring the affordability of expensive homes in relation to mortgage rates is probably inadequate, as many high-end sales are often made for cash, that is, without a mortgage. But given the gaping wealth gap between high-level incomes and the rest, it is natural that, as a percentage of total wealth, the luxury goods market is also far from coming close to bubble territory. As long as the wealth gap persists and there is little reason to believe otherwise, the outlook for the upper tier of the real estate market appears to be as unlikely to be hit as it is for the middle tier.

At the opposite end of the spectrum, however, there are a significant number of people devastated by the pandemic, and recovery has been difficult to say the least.

According to the Mortgage Bankers Association, up to 2 million homeowners were in patience plans back in May last year. About half of these plans expire later this year, which is why the Consumer Financial Protection Bureau (CFPB) has proposed the rule prohibit mortgage companies from starting to sell mortgages until 2022. As is often the case, not everyone benefits from a strong market, and some still need a lifeline to get to the other side.

Overall, the real estate market may be the best in decades. Not everyone benefits from this, and those who really wonder if a soap bubble is accumulating. It doesn’t seem to be the case.

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