Liberal Blogger Has It All Wrong About The Housing Bubble 2.0

Recently, I was sent a link to an article titled "The massive real estate bubble that no one is talking about," and was asked my opinion of the article.

The title suggests we should be fearing the next bubble in the housing market, so I visited the site with peaked interest.

After reading the first few paragraphs, I realized that it was not a real estate website, nor was it a news site, it was merely a website that existed to serve a political purpose. The fact that the author delved into the real estate market was merely coincidental, as the author's intent appears to be simply to "blame the other side,' regardless of the issue.

But that does not mean it should not be read.

Apparently there is a new housing bubble, and it was caused by "the deep-pocketed, cash-flush rich, and the people suffering from it are working poor." Care to guess the political bent here?

Unfortunately, the article was written with a very slanted purpose that devalued a message that could have had merit. There very well might be another real estate bubble forming, and despite providing numerous charts and graphs, the author clearly does not understand what drives a market nor what is specifically going on in housing.

Real Estate Markets Are Driven By Supply And Demand

Property prices are ruled by the forces of supply and demand, just as are other commodities that trade in a free market.

The housing bubble of 2006 was caused by a perfect storm of factors (simplified version):

• Tech bubble burst in the stock market causing money to flow out of stocks
• Much of this money moved into real estate; second homes and speculative investments
• This investment demand in housing caused a flurry of new construction from 2000 through 2007
• New loan programs were created to keep up with the growing demand for homes
• When investors wanted out to move back to stocks, the market was left with a glut of homes for sale
• Mortgage interest rates plunged in order to stay a complete housing collapse

The housing recovery from 2007 through today has been buoyed by low mortgage interest rates. Rates have been historically low for such a long period of time that one could say that there is a "new normal." People who are buying homes today are doing so with borrowed funds being tendered at less than 1/2 of the 50 year average for mortgage interest rates.

This means that consumers have the ability to pay higher prices for homes without having to increase their monthly housing budget. The market has sustained higher home prices through lower mortgage interest rates. But here's the bigger issue and why we might just be sitting on the top of another real estate bubble: 

The Cost Of New Construction Has Skyrocketed

If you really want to know what is going on in housing, perform a study of supply and demand for housing (both locally and nationally).

First look at the number of homes that are selling each month. Take this information and compare it with past years data to determine if the rate of home sales seems high, normal, or low. This information represents "demand."

Then look at supply. Is the current inventory of homes adequate for the current rate of demand? Is it too much or too little? If there is an imbalance, one must look at the reasons for the imbalance in order to attempt to forecast the future for housing.

Here's what many markets are reporting: The supply of homes at affordable levels is falling through the floor, yet new construction for single family homes remains low. Why on earth won't builders come forward with inventory to meet this demand?

It's simple. You just can't build a home at yesterday's prices any more, so the new homes that can be built do not fulfill the needs of what the market is demanding.

Why New Construction Is So Expensive

So much of the cost of residential construction is impacted by an increase in minimum wage, and minimum wage has risen significantly during the housing market recovery.

When we compare minimum wage changes with Tallahassee house price changes (I suspect you will find similar results with data from most other housing markets as well), there certainly appears to be some level of correlation between the two.

In the graph above, the one-year trend of average home prices in Tallahassee is shown in gold and plotted against the right vertical axis. Both the US and Florida minimum wage scales are shown with values recorded on the left vertical axis.

There sure does seem to be a correlation between home prices and wages, right?

Unless you think there will be a reversal in the direction of wages, then you need to come to grips with that fact that building new homes is only going to cost more money in the future. That means when we study supply and demand, we must include the fact that the supply side is changing.

Just because the market crashed and home values fell more than 30% does not mean a new home today is 30% cheaper than it was in the past. It actually is more expensive.

This is a fact that is lost on the author of the article referenced above. Housing costs more to build, so we really need to be looking at the demand side of the market to determine if and when a bubble is forming in housing.

Real Estate Bubble Version 2.0

The real problem that I see for housing is that builders cannot build homes at prices that the market is demanding.

Sure, homeownership rates have fallen, but they needed to fall. They had reached a 50 year high on the back of poorly crafted loan programs, so it is only natural that rates moved back towards a more sustainable level. But this does not mean that demand is falling.

Homes are needed for a growing population, whether they will be consumed by renters or by owner-occupants truly is not significant when performing a study of supply and demand.

Multi-family units are being built at a growing rate in an effort to provide the supply that is needed, but costs for these has sky-rocketed too.

Here's why I see the potential for the next housing bubble. Real estate is battling with inflation, but apparently it is the only market where this is so:

The next perfect storm could very well be tied to rising mortgage interest rates. The cost of new homes will be higher, but the 70% of homebuyers who must borrow to purchase their homes will see their buying power fall. Dramatically. Remember, if rates just return to "normal," that means they will double!

I suspect the government will continue to keep rates low, but a small rise should be expected. 

So what does this mean for you?

If you are an investor, homes in many markets are cheap right now. Do not compare them with what they were in the past, compare them with what they cost to reproduce today. And tomorrow.

I believe home ownership rates will continue to decline, and this will strengthen the position of investors with homes for the purpose of "buy and hold." They will be able to demand higher rents to help offset the cost of construction and maintenance, and they will be rewarded with values that rise faster than investment in other commodities.

If you want to keep abreast of home values in the Tallahassee real estate market, you can do so simply by subscribing to this blog, where we write about housing every day.

Related Links

• Shaun Donovan: Leave The Homeownership Rate Alone!
• Hindsight Shows The Real Cause Of The Housing Market Crash
• Florida Higher Education And The Real Estate Market