Nothing Like 2008: 3 Reasons We’re Not in a Housing Bubble

Nothing Like 2008: 3 Reasons We’re Not in a Housing Bubble

Home values appreciated by about 10% in 2020, and they’re forecasted to appreciate by about 5% in 2021. This has some voicing concern that we may be in another housing bubble like the one a little over a decade ago. Here are three reasons why this market is different.

1. This time, the housing supply is extremely limited

Supply and demand determine the price of any market item. If supply is high and demand is low, prices typically decrease. If supply is low and demand is high, prices naturally increase.

In real estate, supply and demand are measured in months’ supply. “Months‘ supply refers to the number of months it would take for the current inventory of homes on the market to sell given the current sales pace.”

When the months’ supply is above six months, it’s a buyers’ market, and prices will likely soften. When the months’ supply is below six months, it’s a sellers’ market, and prices typically appreciate.

Between 2006 and 2008, the months’ supply increased from just over five months to 11 months. The months’ supply was over seven months in twenty-seven of those thirty-six months, yet home values continued to rise.

In contrast, months’ supply has been under five for the last three years, under three for the previous six months, and currently stands at 1.9 months – a historic low. Because supply is low and demand is high, it makes sense that prices are naturally increasing.

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 “irrational exuberance”  is “unfounded market optimism that lacks a real foundation of fundamental valuation, but instead rests on psychological factors.” In other words, without considering historical market trends, people got caught up in a 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. Before the housing boom, the index stood just below 400. In 2006, the index hit an all-time high of over 868. Again, just about anyone could get a mortgage. Today, the index stands at 122.5, 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, two primary drivers for homeownership. The health crisis is also challenging every household to redefine the meaning of “home” and re-evaluate whether their current home meets 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 genuine.

3. This time, households have plenty of equity

Again, during the housing boom, it wasn’t just purchasers who got caught up in a 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 the mortgage was higher than their home value. 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 a little over a decade ago. Over the last three years, cash-out refinance volume was less than a third of what it was compared to the three years leading up to the crash.

This conservative approach has created levels of equity never seen before. According to Census Bureau data, over 38% of owner-occupied housing units are owned ‘free and clear’ (without any mortgage). Also, ATTOM Data Solutions just released their fourth quarter 2020 U.S. Home Equity Report, which revealed:

“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% or less of their estimated market value…The count of equity-rich properties in the fourth quarter of 2020 represented 30.2%, or about one in three, of the 59 million mortgaged homes in the United States.”

If we combine the 38% of mortgage-free homes with the 18.7% that have at least 50% equity, we realize that 56.7% 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 at a historic low. Demand is real and rightly motivated. Even if there were to be a drop in prices, homeowners have enough equity to weather a dip in home values. This is nothing like 2008. In fact, it’s the exact opposite.