We’ve had the makings of a housing bubble for more than a year and a half. The basic ingredient for a bubble is when demand for homes exceeds the actual supply. What we do not have is the ingredient for a housing bust, which is when the demand decreases and the supply increases.
It doesn’t matter whether it was the dot-com bubble of 2000 or the Great Recession beginning in 2007. Financial bubbles of every kind are driven by speculators. Speculators buy for the short term with a plan to sell for a profit in a matter of months or less. The key here is that speculators drive prices up and then dump the property back on the market for a quick profit. That is the source of the spike in supply. Early speculators repeat the process and new speculators join the cycle as it repeats itself. Speculators themselves inflate the bubble as they repeat the cycle in anticipation of another round of profits. Speculators have no plans of living in these houses. They sell for whatever profit they can make and get out. When the profit becomes too small, they abandon the market because there is no more demand for the high-cost supply... the bubble bursts.
First-time buyers are consumers, not speculators. But they are competing with speculators. The result is a strong pent-up demand that will remain going forward. The bubble will continue to stretch and grow but the rules are changing. Speculator rules no longer apply. First-time buyer rules now apply. The demand will remain, but price increases must slow.
According to Attom Property Data, the volume of house flips during the first quarter of 2021 was the lowest level since 2000. At the same time, both profits and profit margins also declined. Profits are the number of dollars earned on each flip. Profit margins are the percentage of the return on investment. As house prices increase, you must earn more dollars on each flip just to maintain the profit margin. The first quarter of 2021 average rate of return was 37.8%, compared to 41.8% in the fourth quarter of 2020. The number of flips that occurred during the same time was also down. These numbers make speculators skittish. But what is happening is the inflation of the bubble is slowing rather than bursting.
As long as interest rates remain low and the economy avoids a recession, affordability will slowly move forward. First-time buyers will continue saving for a down payment and incomes will go up slowly. These enable steady but slow price increases. The bubble will stretch but not break.
While there is plenty of guessing when interest rates will rise (they will eventually), at the start of the pandemic in March 2020, the 30-year fixed-rate mortgage rate sat at 3.45% and went lower as the Federal Reserve worked to keep the economy functioning. It has consistently remained below 3% since then. However, there is no indication that qualifying for lending standards will become any easier for homebuyers. The result is that first-time buyer demand will remain dependent on low-interest rates and down payments, while the speculator market stagnates from lower profit margins. The historic run-up in home prices has hit the wall of affordability.
Where we are today is that as long as interest rates remain low and buyers can save down payments over time, demand will remain strong. A burst bubble will be avoided but only as long as houses are affordable for first-time buyers.
According to the National Association of Realtors, the U.S. has underbuilt its housing needs by at least 5.5 million units over the past 20 years. That takes us all the way back to the most recent housing bubble that began its growth 20 years ago and resulted in the burst bubble of 2007-08. A lack of housing isn’t good for society, but it is the reason a growing real estate bubble isn’t likely to burst... at least not as long as affordability can consume the low supply.
In light of a housing shortage and the rollback of the renter eviction moratoriums, rents will certainly be going up. Affordability is a huge issue with all housing. Significant rent increases can make homeownership the less costly alternative both short and long term. This will create a second wave of demand as renters begin looking for sources of down payments but will be behind the line of people that have already been saving for months if not years.
The Federal Reserve acknowledges that low mortgage interest rates throughout the coronavirus pandemic have been a “catalyst” for increased housing demand. Adding in the modest economic recovery that brought income growth has kept monthly mortgage payments affordable and has sustained the growth of the real estate bubble. After these catalysts run their course, buyers will hit an even bigger affordability wall. Lack of supply will feed demand, but affordability will be the counterbalance. We are no longer in a real estate boom, but the bubble will not burst as long as low-interest rates can sustain a slow growth in housing prices.
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