Watching for Signs of a Housing Bubble

Watching for Signs of a Housing Bubble

As a bit of a contrarian, whenever things start to look too good, I begin to question the future. And given the strength of the market since the housing meltdown reversed, now is a prudent time to begin closely watching home value appreciation for any signs of a bubble.

I’m not saying I believe a correction in home values is imminent in the near term. It will happen at some point, but no one can say when with any certainty. But any time you see unsustainable growth in the housing market, you are witnessing a bubble, and as I’ve heard it said, “Whatever can’t continue must end.” I would rather consider the prospects of a housing bubble forming within the next two to four years than ignore the potential impact entirely. But I’ll let you gauge the risk yourself.

As part of the last housing crisis, indicators of our downfall began in 2005. However, consumers continued to purchase homes at a rapid pace until 2007—and even into 2008—before it was abundantly clear that we had a big problem. Had people known what to look for in 2005, many could have avoided a disaster.

I monitor five key points relative to the ongoing strength of the housing market:

  1. The median home price in relation to consumer confidence.
    • In 2006, consumer confidence hit an all-time high, and we’re at a similar point right now. Historically, when consumers feel confident, housing prices increase. However, as the recent trend in consumer confidence has not led to a relative increase in home values, we can anticipate either a drop in consumer confidence or an increase in housing prices.
  2. The number of people purchasing homes with cash.
    • When the market is hot, more people pay cash for their homes. We’ve recently seen a drop in the number of cash buyers, indicating a potential slowing in the housing market.
  3. The housing affordability index.
    • With both mortgage interest rates and home values on the rise, the housing affordability index has taken a sharp dive to a level unseen since 2009. Homes have become less affordable.
  4. The percentage of homes that increase in value month over month.
    • Although residential housing values have increased, there are many areas where prices are flat or even declining. The peak of a housing cycle is generally reached once the percentage of homes rising in value ceases to increase. The peak in our current cycle was reached in February 2017, and although this indicator could turn positive once more, it is reflective of the situation in 2005–2006.
  5. The percentage of household income that goes toward housing expenses.
    • Growth is no longer sustainable once the average percentage of household income spent on mortgage or rent payments exceeds 25%. Currently, in 20% of the major housing markets, payments average more than 25%. This is the highest percentage we have seen in a long time.

I’m not predicting a housing crash. I believe now is still a great time to buy a home, especially if you plan to live in it for a while. The relative price difference of owning versus renting overwhelmingly supports buying a home. Markets will always go through cycles. My intention is to educate and point out some of the indicators of a bubble. Maybe my thoughts will help deter buyers whose sole objective is to own a home for its appreciation value; at some point, this kind of short-term investment will no longer be an attractive option. However, the long-term reasons to buy remain firmly in place, especially with the average 4.5% growth rate on real estate. When you do the math, owning a home is a no-brainer.