Just about everyone knows home prices have been on the mend for a while now, though in the grand scheme of things, not very long.
Still, in just over a year or so, prices have chalked double-digit gains, which is great for existing homeowners, especially those formerly in underwater positions.
Unfortunately, the rapid ascent of home prices has to have a cost, and that’s a lack of affordability, or at least reduced affordability, for new home buyers.
I myself began worrying about another bubble back in February, seeing that inventory was highly constrained and bidding wars were thrusting prices to inconceivable heights.
But as the months wore on, I realized it was just the beginning. Home prices were just starting to recover, despite not being all that far from prior bubble highs in some markets.
Now summer is coming to a close and there doesn’t seem to be any end in sight. I thought things were cooling off, but people keep buying at seemingly any price. Listing prices continue to march higher in the hot markets nationwide, and now some areas are even registering new all-time highs.
Again, great for existing homeowners looking to gain enough equity to sell, or for those who purchased a year ago when home prices seemingly bottomed.
But now comes the question of sustainability going forward. If these rapid price increases prove to be too much to bear, home prices could reverse course again.
Of course, that may not happen for years, which is the good news about what could be the beginning of a bubble.
[S&P/Case-Shiller Creator Says Phoenix and Las Vegas ‘Clearly in Bubbles’]
Affordability Below Its Long-Term Trend Line
John Carney over at CNBC is the one who uttered the “B-word,” using the National Association of Realtor’s monthly affordability index as evidence.
The index takes average mortgage rates and median home prices, and assumes a home buyer will put down 20% and keep their front-end DTI ratio at 25%.
When the index is at 100, it means households earning the median income can afford a median home price at an average mortgage rate.
But a reading of 100 isn’t good, not even close. In fact, the last time it was near 100 was in 2006, when it dipped to 101. And we all know what happened next.
This is the great flaw of relying on a real estate agent’s interpretation of affordability…things will pretty much always be affordable.
Anyway, that’s why you have to look at the long-term trend line, not whether the reading is above 100 or not.
That’s what a group of Robert Morris University researchers did – they believe a housing bubble exists when the index value falls below its trend for at least three consecutive months.
During the beginning of the year, the reading was above 200, thanks to ultra-low mortgage rates and home prices that were still unsure of their direction.
But the index has dropped steadily as both rates and prices have risen, and beginning in April of this year, the index fell below its trend line.
The reading has remained below trend ever since, so by the researchers’ measure, we are in a housing bubble.
Bubbles Take a While to Pop
Here’s the good news. Despite apparently being in a housing bubble, it generally seems to take a while for the bubble to inflate and eventually pop.
So just because we’ve started a new bubble doesn’t mean housing is dead.
The Robert Morris economists said affordability fell below trend in early 2004 and it wasn’t until mid-2006 that home prices peaked and began to nosedive.
And seeing that there are more safeguards in place this time around, it could take even longer for the bubble to generate to full size and burst.
At the moment, most homeowners are opting for long-term fixed mortgages, and other than the FHA, most borrowers are required to put a fair bit of money down.
There also aren’t many high-risk loan programs available in the market, unless you consider ARMs, which could balloon higher by the time their first adjustment period comes along.
Perhaps this latest bubble, assuming it exists, has been driven by low mortgage rates, whereas the previous one was fueled by easy credit, including subprime mortgages.
Hopefully this one ends a little better.