The most recent Case-Shiller Home Price Index numbers for March 2022 revealed another 20%-plus jump in median home price year over year. This growth is on top of the red-hot year for housing in 2020 and now means the median home price has increased a staggering 38% over the last two years.
This isn't normal. For reference, the average median home price growth for the last 20 years was 5.5%. Even in the two years leading up to the Great Recession, which seems to be the most comparable time in recent history for such rapid home price growth, values only grew by 24%. There truly has never been a housing market this hot before.
This unsustainable growth in home prices is creating concern over a potential housing bubble. While we truly are in uncharted territory, the verdict on whether we're in a housing bubble isn't out just yet. But here's what the data tells us right now.
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The case for a housing bubble
Housing bubbles are created when there is extreme growth in housing costs, which can be driven by increased demand, speculation, or exuberant spending. Valid demand, the kind that isn't created artificially, can lead to rapid home price growth like we're experiencing today. But when speculation and exuberant spending take over, it could be an indicator of a housing bubble.
Record-low mortgage rates were used to incentivize homebuyers at the start of the pandemic, when government officials were concerned over a housing market crash. This created new demand for homes at a time when inventory was at historic lows and ultimately pushed home prices up fast.
To keep inflation and the housing market from continuing to run wild, the Federal Reserve has increased rates. This makes borrowing money for things like a mortgage more expensive and ultimately cools demand. This seems to be working. Sales are down and inventory is up, yet housing prices aren't slowing down.
Fear over housing prices rising further is causing many to pay more than asking at a time when prices should be cooling to better reflect the decreasing demand, meaning speculation and exuberance are what's pushing prices, not substantiated demand.
The case against a housing bubble
While there are several signs that a housing bubble could be building, one major factor stands against it -- the housing shortage. It's estimated that up to 5 million homes are needed to meet the current demand.
When a product is in supply and in high demand, its value grows, and the only thing that can alleviate that price growth is more supply. Housing supply can come from two places: existing inventory and new homes. New home sales are flattening, with nine months of inventory, the same levels as of September 2007, just before the Great Financial Crisis.
The existing inventory of homes, which do not include newly built ones, is only at a 2.2 months supply. In April 2022, the months supply grew by 15.8% over the previous month, with nearly 11% more homes listed for sale than the month prior, but the levels are still well below pre-pandemic times and a sign we're still in a severely undersupplied market.
The verdict and likelihood of a bubble bursting
For a bubble to burst, it must have the potential to exceed its capacity -- in other words, it has to reach a breaking point. In the Great Financial Crisis of 2008, poor lending practices drove homebuyers to the market in droves, artificially creating demand that pushed prices high. The breaking point was the inevitable default on the popular adjustable-rate mortgages that were given to borrowers who couldn't afford them. Mass defaults eventually led to a recession. While we're certainly in a different market today thanks to improved underwriting criteria, it doesn't mean a different breaking point could cause a bubble to burst.
A recession, which could be fueled by other economic factors outside of lending practices, could lead to many people unemployed and a growing number of borrowers who won't be able to pay their rent or mortgage. The housing market is also battling the issue of affordability, with mortgage rates, rental rates, and home prices rising on top of already record levels. Eventually, there will come a point when people simply can't afford homes anymore and demand will disappear.
Since there aren't specific indicators to signal a red flag for the market, having a concrete answer as to whether we're in a housing bubble isn't easy. However, it does seem there are several signs indicating a bubble could be underway.
If you're concerned over the possibility of a bubble, consider taking a deep dive into your local market drivers and determine what is driving home price growth. While many markets are showing signs of a potential housing bubble, many are still backed by valid long-term demand.
Rather than trying to time the market, make informed decisions when it comes to buying or selling real estate driven by logic and facts, not fear.
