Key takeaways
- Unlike in 2007, the surging housing market is in no danger of crashing.
- Inventories remain historically low.
- Demographic changes will bolster demand in the coming years.
- Buyers today are more credit-worthy than in the 2000s.
- Household balance sheets are also much stronger.
The housing market is as hot as ever, helping to lead the economy out of the recession as builders scramble to keep up with demand. Rising prices have followed, with the median price of new and existing homes jumping 22% and 21%, respectively, from April 2020 to May of this year.
Two big differences from 2007: Inventories are below their historical averages and buyers are more credit-worthy.
But the surge has prompted a question: Is the housing market in a bubble like the one that preceded the financial crisis of 2008 and 2009?
A close examination of the data shows that we are just not there. Not only are inventories below their historical averages, but buyers are also more credit-worthy—two significant differences from the housing bubble of the years before the Great Recession.
While low interest rates and a lack of supply are factors in driving prices higher, underlying demand linked to demographic changes will continue to define the residential real estate market in the coming years. Household finances are also strong. Even though the ratio of household debt to household wealth has increased recently, it is well within manageable levels.
So while housing prices are rising, the combination of a lack of adequate supply and robust underlying demand will most likely avoid a repeat of the housing crash that nearly brought down the U.S. economy over a decade ago.
The 2008 housing bust
Revisiting the previous housing boom, and the crash that followed, can highlight what’s different this time. Before the Great Recession, home building reached all-time highs, with starts and permits climbing well above the 1.5 million annualized rate that represents equilibrium in the market.
The National Association of Home Builders index hit new heights in 2005. Money was flowing into the housing markets, the government was promoting home ownership for all and financial institutions vastly expanded those who could qualify for financing.
Relaxed lending standards fueled the surging demand, and adjustable rate mortgages, often provided with little or no money down and unverified income, became a time bomb in the financial markets.
It couldn’t last. Borrowers eventually could not repay their mortgages, causing them to default. And the bubble popped.
After the bust, the market went into a slump as builders and buyers lost confidence. Over the next decade, builders, wary of taking on risk, significantly underbuilt new homes as inventories of existing homes for sale gradually declined.
At the same time, the seeds for an inventory crunch were being sown. Millennials reached their peak home-buying age, and corporations like American Homes 4 Rent, which was founded in 2012, saw an opportunity to generate cash flows by snapping up single-family houses at low prices and renting them. This strategy, which only further constricted supply, is now being deployed by some of the nation’s most established builders.
Fast forward to today. Builders are catching up, with housing starts and permits climbing above the 1.5 million unit annualized equilibrium in October 2020 and largely staying there since then. The National Association of Home Builders confidence index has been above 80 since September.
What’s different this time
The concern of a bubble has followed. But there are key differences between today’s housing market and the pre-Great Recession housing market.
- Existing home inventory levels are significantly below historical averages. At a little more than 1.2 million homes as of May, inventory levels are significantly below the historic average of 2.5 million. The supply for existing homes sits at two and a half months, far below the six-month supply that creates equilibrium in the market.
- Buyers today are more credit-worthy. During the pandemic, many lenders raised their borrowing standards. Lenders were requiring higher credit scores, larger down payments and even second employment verifications. The tightened standards were in part an outgrowth of the pandemic, when lenders faced substantially more risk as unemployment hit record levels and entire parts of the economy closed. While it is likely that these standards will loosen, lending requirements remain more stringent than before the Great Recession, resulting in more credit-worthy buyers.
The takeaway
While it may feel that housing is primed for a bubble, the economics are straightforward. With limited supply and robust demand, prices will rise.
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