Home values are increasing at an alarming pace. Some cities like Sacramento, CA and Charlotte, NC have seen over 13% price increases in the last year. Whenever home values suddenly increase, we hear worries of being in a “housing bubble” and that the bubble is going to inevitably “burst.” But what does that really mean?
What Causes a Housing Bubble?
First, it is important to note that an increase in home values and a housing bubble are not always the same. A bubble starts with values increasing, but there is more to it.
A housing bubble usually starts with an increase in demand due to limited supply. During this time, real estate speculators will pour money into the market in hopes that values will continue to increase. Their actions will further drive demand up and artificially drive home values up as well. However, there comes a turning point where demand decreases while supply increases which causes prices to drop quickly. That is when the bubble bursts.
What Does Today’s Market Indicate?
Casual real estate observers have feared that we were in a housing bubble and that the bubble would burst for years now. However, real estate experts do not call current market conditions a bubble and they do not see a burst anytime soon.
Real estate values are increasing at a rate that is not sustainable, and values are expected to take a slight dip once interest rates rise. Most importantly, we must keep in mind that the conditions in the years building up to the 2007 crash was very different from the conditions we are seeing today. We do not expect to see anything like the catastrophic crash of 2007-2008.
Let’s look at the situation a bit closer. Yes, values are increasing, but most of the home purchases are for primary residences, not from investors trying to turn a quick profit. Something else that is different is that lending is much stricter than it used to be.
In the early 2000s, just about anyone who wanted a mortgage could get one even if they had poor credit, no money in savings, and no money for a down payment. Additionally, lenders did not require borrowers to document or verify their income either. These loose lending regulations allowed people to borrow far more than they could afford. What made the situation even worse was that adjustable-rate mortgages (ARM) were frequently used. This meant that a borrower’s monthly payment could increase based on the market interest rates. Once rates increased, borrowers began to default on their loans, spiraling into foreclosures, and eventually, the bubble burst.
Lending practices today, however, are much different. What the lenders require from borrowers is much stricter in order to prevent the colossal number of foreclosures that we saw before. In 2020 the typical credit score for mortgage borrowers was at a record high of 786, showing that borrowers should also be much more stable than in years past.
Another variable is that housing construction was at an all-time high in the early 2000s. This also decreased demand, also contributing to the bubble burst. This is not the case today. Currently there is a severe shortage in the number of new construction homes being built. The National Association of Realtors estimates that we need 4 million homes to be built to see a balanced market. Experts are hopeful that 1 million new homes will be built this year which is still not nearly enough to satisfy demand.
No Need to Panic
Real estate experts say there is no need to panic. The causes of today’s price appreciation in the market does not indicate we are in a bubble. It is worth mentioning that the real estate market is cyclical meaning values will go up and down. You can expect a slight dip in the next couple of years, but nothing as catastrophic as a we saw a little over ten years ago. If you can buy a home in today’s market, you should.
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