Home values appreciated by over ten percent in 2020, and they’re forecast to continue rising this year. This has some voicing concerns that we may be in another housing bubble like the one we experienced a little over a decade ago. Here are three reasons why that’s not the case and the market is completely different today.
1. This time, housing supply is extremely limited.
The price of any item is determined by supply and demand. If supply is high and demand is low, prices normally decrease. If supply is low and demand is high, prices naturally increase.
In real estate, this balance is measured in months’ supply of inventory, which is based on the number of current homes for sale compared to the number of buyers in the market. The normal months’ supply of inventory for the market is about six months. Anything above that defines a buyers’ market, indicating prices will soften. Anything below that means it’s a sellers’ market in which prices normally appreciate.
Between 2006 and 2008, the months’ supply of inventory increased from just over five months to 11 months. The months’ supply was over seven months in 27 of those 36 months, yet home values continued to rise. Months’ inventory currently stands at 2.4 months – near historic lows. Remember, if supply is low and demand is high, prices naturally increase.
2. This time, housing demand is real.
During the housing boom in the mid-2000s, there was what Robert Schiller, a fellow at the Yale School of Management’s International Center for Finance, called irrational exuberance. The definition of the term is, “unfounded market optimism that lacks a real foundation of fundamental valuation, but instead rests on psychological factors.” Without considering historical market trends, people got caught up in the frenzy and bought houses based on an unrealistic belief that housing values would continue to escalate.
The mortgage industry fed into this craziness by making mortgage money available to just about anyone, as shown in the Mortgage Credit Availability Index (MCAI) published by the Mortgage Bankers Association. The higher the index, the easier it is to get a mortgage; the lower the index, the more difficult it is to obtain one. Prior to the housing boom, the index stood just below 400. In 2006, the index hit an all-time high of over 868, meaning nearly everyone could qualify for a mortgage. Today, the index stands at 128.1, which is well below even the pre-boom level.
In the current real estate market, demand is real, not fabricated. Millennials, the largest generation in the country, have come of age to marry and have children, which are two major drivers for homeownership. The health crisis also challenged every household to redefine the meaning of home and re-evaluate whether their current home met that new definition. This desire to own, coupled with historically low mortgage rates, makes purchasing a home today a strong, sound financial decision. Therefore, today’s demand is very real. Remember, if supply is low and demand is high, prices naturally increase.
3. This time, households have plenty of equity.
Again, during the housing boom, it wasn’t just purchasers who got caught up in the frenzy. Existing homeowners started using their homes like ATMs. There was a wave of cash-out refinances, which enabled homeowners to leverage the equity in their homes. From 2005 through 2007, Americans pulled out $824 billion in equity. That left many homeowners with little or no equity in their homes at a critical time. As prices began to drop, some homeowners found themselves in a negative equity situation where their mortgage was higher than the value of their home. Many defaulted on their payments, which led to an avalanche of foreclosures.
Today, the banks and the American people have shown they learned a valuable lesson from the housing crisis. Cash-out refinance volume over the last three years was less than a third of what it was compared to the 3 years leading up to the crash.
This approach has created levels of equity never seen before. According to the U.S. Census Bureau, over 38% of owner-occupied housing units are owned ‘free and clear’ (without any mortgage). In addition, the ATTOM Data Solutions first quarter 2021 U.S. Home Equity Report reveals:
“17.8 million residential properties in the United States were considered equity-rich, meaning that the combined estimated amount of loans secured by those properties was 50 percent or less of their estimated market value… The count of equity-rich properties in the first quarter of 2021 represented 31.9 percent, or about one in three, of the 55.8 million mortgaged homes in the United States.”
If we combine the 38% of homes that are owned free and clear with the 19.8% of all homes that have at least 50% equity (31.9% of the remaining 62% with a mortgage), we see that 57.8% of all homes in this country have a minimum of 50% equity. That’s significantly better than the equity situation in 2008.
Bottom Line
This time, housing supply is drastically lower. Demand is real and rightly motivated. Even if prices were to drop, homeowners have enough equity to be able to weather a dip in home values. This is nothing like 2008. In fact, it’s the exact opposite.