Real Estate Bubble in the near Future

Seven years have passed since the worst house price bubble in U.S. history, and Americans are once more seeing real estate as a winning investment.  But is it truly over?  Could we already be on the brink of yet another housing disaster?  According to a 20-city study by Case-Shiller, prices rose an average of 11 percent in the twelve-month period that ended in March. Increases of more than 20 percent were seen in Phoenix and Las Vegas, both of which were at the core of the 2006 housing collapse. While these sharp increases are not typical in all cities, house prices in nearly every market are at or well above the 25-year average. Readers should keep in mind that averages have been severely pushed up by the recent price rise.

There is of course, argument as to whether these price increases really constitute a bubble. After all, real estate bubbles are characterized by rapidly increasing property valuations that quickly become unsustainable relative to incomes and other elements of the economy. However, bubble proponents argue that any type of economic bubble is difficult to identify except in hindsight. This is especially true of the real estate market, which is less liquid than the stock market. One factor that indicates that there might be another bubble on the horizon is the availability of adjustable rate mortgages.

In a stable market, monthly mortgage payments should be slightly higher than rent payments because mortgages get a tax break. Lower payments have made rental the more attractive option. However, adjustable rate mortgages need to produce payments near or even lower than rental payments to be a good buy.  This is due to the fact that with ARM’s, there is no security of a fixed payment. A survey of the top 100 metropolitan areas has shown that it is actually cheaper to buy than to rent in every city. Currently, mortgage payments only take up 13 percent of median family income.

Another reason for the potential real estate bubble is the likelihood that credit standards for would-be home buyers will fall sometime in the near future. This is because any lender that loosens standards will increase asset volatility that makes all loans riskier, enabling the lender to charge a higher rate and gain a market share.

The rapid increase of purchasing power will likely drive home prices into a bubble. It might seem that lenders have not learned from the 2006 bubble, but the fact is that a perfectly competitive mortgage lending market will naturally enter a bubble phase. Until now, regulations in the lending industry, not to mention the quiet collusion of major players, have prevented such competitiveness from being reached. The increase of prices in already bubbly markets such as those mentioned above may put upward pressure on the lending industry, causing said regulations to be relaxed.

Critics of the bubble say that the current growth in the home buying market is short lived. They also remain optimistic that growth in the home building industry means that supply will catch up with demand. However, the recovery of new home construction has been slow; levels are still only half of what they were prior to the 2006 bubble.

Home ownership is still a reality for most families. Affordability levels still remain at 17 percent above the ten year average, though they are down 18 percent from pre-2006 levels. However, increased competition between would-be buyers with cash-paying investors eager to flip homes for a profit has already pushed prices upward in key markets. This decline in affordability, along with the slow growth of the new home construction industry, could result in a bubble worse than that of 2006.