How to Spot a Housing Bubble
The recent rise in home prices has spawned the fear of a bubble that might burst, resulting in a housing downturn like what we experienced in 2008-2012. While any imbalance in a market is cause for investigation, there doesn’t appear to be cause for alarm. At least not yet.
From the tulip craze in the mid-1630s to the financial crisis that nearly took down the entire U.S. economy in 2008-2012, “excess exuberance” has fueled market imbalances that have led to crashes in otherwise smoothly-functioning markets. From profitless tech companies whose stocks soared in value two decades ago to mortgage lenders who issued collateralized debt obligations a decade ago, overconfidence is often fingered as the cause for bubbles--usually after the crash has happened.
But it’s hard to find a culprit for today’s run-up in housing prices. It seems we’re simply experiencing a convergence of high demand--the huge demographic of Millennials are squarely of home-buying age--and low supply--Baby Boomers are electing to retire in place. An often overlooked element of limited supply is investment funds that bought significant numbers of distressed sale residences during the financial crisis and now lease them out for handsome rents instead of selling them, further strangling the supply of homes to buy.
We watch for trigger points, like leverage. When everyone borrows against everything they own or buys on margin (think the stock market crash of 1929), there is no buffer to absorb a shock to the system and the house of cards collapses. But today’s mortgage underwriting standards are more strict and homeowners don’t appear to be refinancing repeatedly to raid their homes’ equity like they did in 2008-2012, so it doesn’t appear over-leveraging is an issue.
Another trigger point is when family income can’t keep up with appreciation. But Denver has seen 25% employment growth against a 17% increase in population since 2010, so it appears that at least our metropolitan area is responding to expansion appropriately.
Today’s low interest rates certainly contribute to housing affordability, and when they inevitably rise we can expect demand to taper off accordingly. But that should not bring a sharp blow to the market that causes a bubble.
So for now, we see the current market as a harmonic confluence of lower-than-normal supply & higher-than-normal demand that will cool sometime in the future, but not come crashing down around us.