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Another Look at if We are Headed for a Real Estate Bubble

By Brian Kline | August 6, 2021

Let’s not lose sight of the fact that it was a housing market crash 13 years ago that set off a worldwide recession. Not that we are on the verge of another Great Recession, but we must be aware of the ongoing signals of distress in the real estate market if another meltdown is to be avoided.

Home prices are on track to reach an unaffordable and unsustainable 20% increase this year. The two powerful forces driving prices are the nation’s unshakeable faith in homeownership and an unprecedented streak of low-interest rates. As the market again plows bullishly upward into unaffordable home prices, the most likely cushion from a full market meltdown this time will be stricter bank loan regulations and homeowner equity.

What We Learned From the Great Recession

The housing bubble bust of 2008 resulted in almost 10 million Americans losing their homes to foreclosures and short sales. Values plunged 30% and more in some areas. Collectively, the financial loss was about $7 TRILLION. Home values slid backward for 4 years before hitting bottom in 2012. With some losses continuing through 2014. It took almost a decade for the broad market to recover.

What is very different as we stare into another housing abyss is that in important ways, the economic situation this time is the opposite of what it was during the Great Recession. Today, there is a severe housing shortage with many want-to-be-buyers but few that can afford a mortgage. Back then there was a glut of housing and buyers could qualify for NINJA loans (no-income, no-job, no-asset loans).

What is also notable today is the end of COVID-19 driven rental eviction moratoriums. During the Great Recession, foreclosures and collapsing prices hit homeowners first, then the recession spread into rental markets. This time, we face the risk of massive rental evictions into a housing shortage. However, pandemic forbearance programs have allowed homeowners to postpone their monthly mortgage payments without suffering penalties. Meaning foreclosures are nowhere near as likely but rental evictions are almost a certainty.

How We Might Avoid Another Widespread Real Estate Bubble

Adjustable-rate mortgages were a significant contributing factor to the Great Recession foreclosures and short sales. When interest rates rose, monthly payments increased on ARMs, leaving many borrowers unable to pay their mortgages. Approximately 20% of home loans were adjustable in the ten years leading up to the recession. At that time, the so-called teaser interest rates (which lasted for the first year or two) made a home seem affordable but soon ballooned into mortgage payments that homeowners could not pay.

Following the recession, the number of ARMs dropped below 1% of mortgages being written but by 2018 had crept back up to about 6% of all loans. The number of ARMs stayed at low levels for a few years because of historically low interest on 30-year mortgages. In January of 2021, Ellie Mae estimated the market share for the ARM mortgage at about 4% of all mortgages sold. But this past spring, the number of ARM loan applications has again been on the rise – increasing slightly each month.

However, the rules on ARMs have changed. Some of the riskiest features - prepayment penalties that keep borrowers locked into loans with expensive terms - are gone. Loans that qualify applicants based on teaser rates are no longer allowed - today’s underwriting guidelines must take into account a borrower’s ability to repay the mortgage not just at the teaser rate but for the life of the loan. And the most popular ARM mortgage - the hybrid with introductory rates that can be fixed for three to ten years - is further backstopped with caps in rate increases and lifetime limits to keep loans affordable. ARMs are now better regulated by the government, and have both periodic and lifetime caps so that your rate can only adjust a certain amount each year and over the life of the loan – usually not more than 5%.

Perhaps this is enough to prevent a repeat of the Great Recession housing collapse. But the unknown is always a big question. There could easily be a new and unforeseen economic pothole that could devastate today’s real estate markets. A similarity between the pandemic and recession markets was high unemployment. The difference is that the recession unemployment lasted much longer. Also, the millions that went through foreclosure and short sales could not qualify for a new mortgage for many years. The demand for homes remained low for many years (the opposite of today’s markets).

That brings up another major difference between then and now. Demand for home purchases is very high today and significant value appreciation gives new buyers instant equity. As long as equity and demand remain high, short sales and foreclosures should be few and far between. Even if homeowners can no longer afford their mortgage, they can sell for a profit.

Very different today is the shortage of workers that is leading to higher wages. Will rising wages and ample employment continue to drive high demand for homeownership? Will this continue to drive home prices higher? Will new home construction catch up with demand? Or is there some new mix in today’s real estate markets that will cause a new and unforeseen real estate bubble to burst?

It’s important to stay informed about market trends, consumer sentiments, and expert insights. Please share by leaving your comment.

Photo by Alexas_Fotos on Unsplash

Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].

Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years with articles listed on Yahoo Finance, Benzinga, and uRBN. Brian is a regular contributor at Realty Biz News
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