Is The Booming US Housing Market In A Bubble?

Ever since the global financial crisis, investors have watched out for overheating in the United States’ housing market as a sign of possible issues. Prices de-grew in the US residential real estate market between 2006 and 2012, and have continued rising since.

The price growth calculated on the basis of the year on year change in the S&P CoreLogic-Shiller Home Price Index indicates that between April 2021 and October 2021, prices increased at rates of more than 15 per cent.

Between August 2020 and August 2021, prices increased by 19 per cent. Despite regular claims about the housing market being in a bubble, data shows that it isn’t the case.

Better Underwriting Standards

The 2006 period saw sub-prime credit being doled out with teaser rates, lackadaisical lending standards, no down payments, and no documentation. However, with the episode still fresh in investors, regulators, and lenders’ minds, the credit standards are much tighter today.

In addition, the period saw over-building with easy credit and rocketing housing prices. After the bust, prices collapsed and the value of residential homes continued falling for the next few years.

Today, the situation is completely different. Home inventory in the US is at a 40-year low with under-building of residential real estate. With a building shortage in several areas, increasing prices of land and home-building materials, the supply of new homes could be constrained.

The lead time between construction and occupancy can be a factor as well. With regulatory constraints on building in several areas, the supply situation might not improve for some time to come.

A sign of safety for anyone worried about a bubble in the housing market is the higher lending standards. For the calendar year 2020, the average credit score of the borrower stood at upwards of 780 as opposed to an average credit score of 707 in 2006.

Clearly, banks are not lending out to risky customers who can land them in trouble later. The previous bubble situations saw indiscriminate lending to sub-prime borrower segments that could not pay back the money they owed.

Lower Mortgage Rates

Lower interest rates have played a rate in inducing demand. An analysis by JP Morgan showed that a one percentage point drop in mortgage rate increases demand for the housing assets by 10 per cent.

With the Fed lowering interest rates to help the country tide over the pandemic, mortgage rates had fallen just about one percentage point and demand was approximately up by 9 per cent. The saving for buyers can be quite substantial even with half a per cent decrease in mortgage rates, especially for the higher end of the residential market.

With participants being forced to spend more time indoors with the work from home regime, the switch to a larger house during a period of low mortgage rates made sense. Therefore, the current boom in US housing is probably not a sub-prime debt-fuelled party as the past bubble periods.

Millennials Lead Buying

Contrary to the popular opinion that millennials do not wish to own houses, the current push in housing is being led by millennials and baby boomers. These millennials have reached the age of 30, an age at which the former generations bought their first homes.

According to a report by the Wall Street Journal, the generation had accounted for 67 per cent of the first-time mortgage applications in the first eight months of 2021.

While the popular narrative always concluded that millennials did not wish to own homes, the lack of demand could have come from a slow economy after the 2008 financial crisis when millennials were just joining the labour force.

Price Growth could Slow Down in 2022

Freddie Mac and Fannie Mae, two large lenders expect the rates for house prices to grow at around 7 to 8 per cent since 2022. Other models even predict a drastic fall in growth rates to 2 to 3 per cent. With the Fed looking to increase interest rates, demand is likely to return to normal levels over time as mortgage payments go up significantly.

US workers have seen wage rises in 2021, but the price of housing has grown at a much higher rate. Expected growth in wages for workers is estimated to be at 3.9 per cent in 2022, lower than expectations of housing price rates.

In addition, a potential detractor to moving into larger homes could be the end of the work from home trend. Even if the growth in home prices stalls for a while, the prices would still remain higher than the pre-pandemic period.