Is US Facing Another Housing Bubble?

Housing prices in the West and throughout the nation are on the rise. Construction is up and so are prices. In many areas, the median value of existing homes has surpassed the pre-recession levels seen in 2006. 

With real estate and housing values increasing, some are wondering if we are due for another correction. They wonder whether we are entering a new bubble that could burst like the last one. There are several things to consider as we try to assess the current state of the housing market.

Big Home Price Increases. An increase in prices is not, by itself, a reason for alarm. Increasing home prices is a sign that people have confidence in the housing market and are willing to make long-term investments in these assets. However, when home price appreciation exceeds the increase in household wages, homes become less affordable. While personal income increased 3.6 percent in the last year, home values increased double that. These increases can be particularly difficult for first-time homebuyers or those on fixed incomes who need to move. As home prices continue to increase at high rates, more people will be priced out of the housing market.

Increasing Value of New Construction. In addition to the increasing sales prices of existing homes, the value of newly constructed homes is also increasing dramatically. This means that homebuilders are once again constructing homes with many of the pre-recession amenities included. In addition, because of more stringent zoning and building code requirements in many areas, builders must construct homes to higher standards, which adds additional costs to new homes. 

Rising Interest Rates Make Homes Less Affordable. The Federal Reserve has been increasing interest rates for the past couple of years and has committed to continue this pathway as long as possible. In response to the Great Recession, the Fed dramatically dropped interest rates to historic lows and kept rates very low for several years. Fed governors are concerned that ultra-low interest rates can cause long-term problems, such as high inflation and asset bubbles, so they want to return rates to levels consistent with historic norms. However, as interest rates increase, the cost of financing also increases. Inflated home prices coupled with higher interest rates can make payments more difficult to afford.

While an increase in home prices brings some reasons for concern, there are also reasons why the current situation may not end the same as last time.

The Underlying Economy Remains Strong. The economy of the United States, while not as strong as many would like, remains resilient and continues to grow. The current business cycle is in its eighth year of expansion, with continued growth in employment and very low unemployment, which is pulling more people off the sidelines and back into the labor force. Consumer and business confidence in the economy remain strong, which have fueled strength in the stock market. Continued economic growth will provide more fuel to keep the housing market growing. 

Labor Shortages Are Perpetuating a Housing Shortage. One of the main reasons for home price increases over the past few years is that not enough homes are being built. Several industries are suffering the effects of a lack of skilled labor, and the construction sector is no exception. A shortage of skilled labor in construction is causing a shortage of homes. Simply put, homebuilders don’t have the ability to keep up with demand. 

In fast-growing areas like Utah and Idaho, high population growth and strong in-migration will keep demand for homes strong. Therefore, even if housing demand starts to weaken at the national level, it could remain strong in high-growth areas with strong economies. 

Borrowers Are Not Overextending Themselves. One of the signs of an overheated market can be investors who act in ways that are inconsistent with underlying conditions. Fed Chair Alan Greenspan famously referred to this behavior as “irrational exuberance” in the late 1990s. There were many signs of this heading into the Great Recession of 2009, as borrowers used increasingly risky funding mechanisms to purchase homes. Borrowers and lenders in the current economic environment are not showing that same risky behavior. In fact, foreclosure rates have been dropping for the past few years and are lower than during the last economic cycle.

Today’s housing market is stronger and more secure than before the Great Recession. While high home prices are making affordability more difficult, underlying economic conditions remain stable and the home financing sector continues to show strength, which will help prevent the kind of instability that happened in the past. 

To read more economic news compiled monthly, please view our Economic Snapshot report on www.zionsbank.com/economy.