Speculation has proliferated in recent weeks regarding the future of the residential real estate market. The market has continued red hot for nearly a year now. Is there a bubble waiting to burst? Are hyper-competition and bidding wars simply the new normal? As usual, the truth lies somewhere in the middle.
Google analytics show that there has been a massive spike in people concerned about the future of the real estate market. Searches for “When is the housing market going to crash?” went up 2,450% in March and April.
These concerns largely stem from the hyper-competitive seller’s market that has been the biggest story of residential real estate over the last year. Home inventory is at an all time low due to low interest rates, slow activity in new home starts over the last decade, and a number of cultural factors brought on by the pandemic.
According to a report from Redfin, median home prices have risen 17% year over year to $338,225, the highest ever recorded. 59% of homes were under contract within two weeks of going on the market. There is far more demand for houses than there is supply. And there seems to be little sign of this changing in the short term.
This unusually frenzied market is unlike anything since the 2000s and has thus sparked concerns about the possibility of a real estate bubble similar to that of 2006. But most economists are not too concerned. The biggest contributing factor to the Great Financial Crisis was not a hot real estate market, so much as reckless lending practices. These have been largely corrected since.
According to research by Morgan Stanley, 40% of all mortgages on the market from 2004-2006 were products with a high risk of defaulting, such as subprime mortgages and balloon mortgages. In recent years, this number is down to 2%. In the wake of the 2006 financial crisis, lenders are much more cautious and as a result the market is much more secure.
Given this, it seems highly unlikely that the market is headed for a catastrophic collapse like what was seen in 2006. Warnings about a coming financial crisis play too much into the hype and pay too little attention to the realities of the market. The reckless lending that caused the financial crisis simply do not exist anymore thanks to tighter regulation and better business practices.
On the other hand, the value of homes cannot simply appreciate forever. The unprecedented number of homes sold sight unseen and the frequency with which buyers have waived inspections in order to secure a contract has likely resulted in many homes selling for more than they are actually worth. There is also the possibility of inflation, which if it occurred on a large scale could have a big impact on mortgages.
Once the factors contributing to low supply, in particular ultra-low interest rates, run their course, demand for homes and the attendant high prices will come down. This is not a matter of the bubble bursting as much as it is the normal and healthy process of the market correcting itself.