Are We Currently Experiencing A Real Estate Bubble?

Article Summary

• The current housing market in the US has made its way back to pre-Great Recession levels.
• Interest rates are rising, which will tend to cool off the increasing housing prices.
• Significant factors that will cause a market correction in the next two years include the Federal Reserve’s monetary policy and tightening of credit by lenders.

Shopping for a new home seems to cause a person to ask the question, “Is now the right time?” I personally have been looking for an investment property, and have found myself asking that question over and over again, hoping that I don’t end up in a situation where I’m buying at a high point. Although real estate generally tends to trend up in value, it’s still better not to put yourself in a situation where you could have put off purchasing for six to twelve months and picked up a much better deal.

The 2008 Real Estate Market Crash

The real estate market crash of 2008 was a catastrophic situation that affected many of the households in the United States directly, and also caused a credit crisis that affected economies all over the world. Over that time period, real estate became an unstable investment not just for speculators, but for first time home purchasers and other potential homeowners. Previous to what’s commonly referred to as “The Housing Market Crash of 2008” or, as Wikipedia (the modern trend setter for terminology) refers to it, the “United States housing bubble”, real estate had long been a solid investment.

Whether you were buying a home for yourself or investing in property with the expectation that the value would gradually go up, land and home prices were generally predictable.

But the United States housing bubble changed all of that. In the years following 2006, when home prices reached their peak levels nationally before seeing steady and steep declines until 2012, it was hard to know what the value of a home was.

In many of the neighborhoods where I live in Utah, there were so many houses waiting for buyers for years, especially those priced over $300,000, that homes in the same area that were very similar in terms of location, size, upgrades, and other factors that contribute to a home’s value, had asking prices that were drastically different. In one more affluent (prior to the crash) neighborhood where my wife and I were shopping for homes in 2009, two homes made from almost identical floor plans, on very similar lots, had asking prices that were $400k and $700k. In that environment, it was obvious that the local economy simply couldn’t consistently determine the value of a home, especially those in higher price ranges.

Lessons From the United States Housing Bubble

There has been lots of speculation about what caused the 2008 housing crisis. Although looking back, the impending meltdown have been predictable (and actually was predicted by lots of people in the know), the crash took most of the country and the world by surprise, especially naive laymen who jumped in on the speculation towards the end of the good times only to have some part of their savings wiped out after buying high and being forced to sell low.

I have a relative who was one of those. After hearing so much about how much was being made by friends of friends, he jumped and put a large down payment on a home that he was going to be into $400k expecting to sell for $500k or more. Six months after committing to the deal, and while the home was inching closer to being ready to sell, he couldn’t find anyone interested in the home for $400k, nor for $350k, maybe for $300k, which meant a $100k loss.

Amidst all the speculation about what caused the big US housing bubble, it is clear that there were some market fundamentals that were ignored by many people who bought at the wrong time, and who found themselves on the wrong side of the bubble. It is also clear that there were lots of unscrupulous market influencers who through their dishonesty ultimately deprived millions of unsuspecting Americans of a good deal of cash.

It has been over 10 years since that housing bubble began to burst, and confidence in the housing market has mostly been restored, although those who were impacted by the crash are likely still skittish.

What did we learn from the great US housing bubble of 2008?

The underlying cause of the housing crash of 2008 was something called the subprime mortgage crisis. The unnatural increase in house prices that led to a housing bubble in 2008 was built on a framework of unscrupulous borrowing practices, housing speculation by investors, and lending institutions taking risks that were not only unwise, but very often dishonest. Mortgage fraud and predatory lending had become an “epidemic” according to the FBI in a report issued in 2004.

The solution for preventing a repeat of that housing collapse disaster has had to come from increased regulation of the housing industry from the federal government. The Housing and Economic Recovery Act of 2008 was enacted, which gave the federal government much more control of the lending process and which added significantly more restrictions to lenders. This expansion of government through lending is yet another example of how a collective abdication of personal responsibility can drastically affect everyone in the society, including those who have been responsible with their finances.

My Own 2008 Real Estate Story

The real estate market is as complicated as many other elements of the US and worldwide economies. It’s impossible to predict anywhere close to exact timing for a major correction. However, there are several signs that a market reset is coming.

When my wife and I were finishing school and looking to buy a home in 2006, we noticed that prices had surged over the previous three years since the last time we had shopped. We read about or observed first-hand with friends and other people knew about an abundance of interest only loans, risky ARMs (adjustable rate mortgages), and aggressive speculation by homebuilders and me-too investors jumping into the fray to make some quick money. We studied graphs of median household incomes versus house prices in our local market as well as nationally. By spending a few hours each month studying the factors that contribute to healthy and stable real estate markets, we recognized that in 2006, things were getting out of hand.

Instead of buying a home along the stretch of Utah County that was the most coveted, we went south to a more rural area and found a very modest home. It was one that would be perfectly functional for our small family. Over the next four years, we enjoyed a comfortable home we’d bought at a comfortable price, and watched as the trends we’d observed brought the housing market to its knees in 2008.

Following that crash, we were able to find a more more desirable home in an affluent neighborhood at half the price it was valued at only two years prior.

The moral of my personal experience: understanding and paying attention to the fundamental signs of an impending housing correction can keep you from being set back years financially.

When we moved into the neighborhood, we heard stories from many of our neighbors who had not been so “lucky”, who bought their nice homes on the crest of the housing wave that led up to that crash. They struggled when their home values dropped in half, especially since that was coupled with a recession and its impact towards lowering wages. Many people I know have still not quite recovered from the effects of 2008.

What Makes the Housing Market Correct?

A survey done earlier this year by Zillow polled more than 100 real estate experts to get their take on when the US market might expect another recession. Their collective prediction puts another housing correction sometime during 2020. Because of the many different factors affecting if or when a correction happens, that prediction is certainly fluid. However, paying attention to what those factors are can help any individual make much more intelligent decisions about their own personal real estate buying and selling decisions.

In general, the following  factors cause the real estate market to correct to home prices drop:

• Federal Reserve Monetary Policy: Increase in interest rates by the Federal Reserve naturally translate into monthly costs, meaning that consumers cannot afford as much as they could when rates are lower. The key interest rate has been raised by the Federal Reserve 3 times in 2018, and that rate is expected to be raised once more in December of this year. Already the formerly very hot US real estate market has been softening as a result of the higher interest rates. The majority of real estate professionals (55 out of 99) predicting a correction in the next two years in the Zillow survey identified “monetary policy” as the principle reason for the correction.
• Tightening of Credit by Lenders: This factor is related to government regulated interest rates. However, it is much more highly dependent upon the attitudes of lenders. The Zillow survey observed that while credit is loosening for less risky borrowers (those with lots of cash and high credit scores) it has been tightening for those who have low credit scores and who can’t come up with a significant down payment for a home. It appears that lenders are highly conscious of the results of the 2008 crisis, and are being much more conservative in their attitudes towards unproven borrowers.
• Supply and Demand for Housing: This factor is the foundation for pricing in any market. If there are more houses available than people who are looking to buy, the market drops. Although demand has been very high over the past several years, it’s apparent that supply is catching up to demand, and that by 2020 the higher interest rates will keep the demand/supply curve in check.
• General State of the Economy: The US economy has been doing well for and has showed signs of vitality since 2017. This has helped the real estate market grow and house prices to increase, but at some point natural wages cannot overcome rising high interest rates.

Whether there is a housing market correction in 2020, or if it’s earlier or later, paying attention to your own local housing market and observing the factors described above will help you map your own personal situation to what’s happening with real estate so you can make a good decision.

My own approach to gearing up for a correction in 2020 is to not be in a hurry when shopping any specific piece of real estate, and to place offers that anticipate that the correction will likely happen. That type of conservative approach has served me well in short terms and over almost two decades of being a buyer and seller of real estate.