An Argument For A Housing Bubble
The housing market. It’s been one of the hottest topics over the past two years as COVID, along with other macroeconomic factors, motivated people to make residence changes. Whether it was family related, a new work opportunity, or simply a lifestyle change, there’s no argument that the housing market has boomed. Since 2020, home prices have increased 16.9% and approximately 6.12 million homes have been sold, the highest number since 2006 (Bahney). Now, as we (hopefully) begin returning to a no-mask, no cancellation, and in-person type of world the tide may be beginning to shift regarding the housing market. Could we potentially see another housing market bubble given the current state of the market and factors such as inflation and interest rates?
Normal macroeconomic financial literacy tells us that as the price of an asset increases, the discount (interest) rate should decrease, and vice versa. Unfortunately, this doesn’t apply to value and interest rates on homes. As Ben Carlson, CFA and portfolio manager for Ritholtz Wealth Management LLC, wrote about this past week, every prolonged rising rate environment over the past 50 years saw housing prices grow when mortgage rates went up (Carlson). Interestingly enough, rising interest rates doesn’t necessarily mean the prices of homes will cool off. A survey conducted by Redfin this past month indicated that 47% of prospective home buyers would actually feel more of a sense of urgency should mortgage rates exceed 3.5% (Carlson). The housing market is already out of supply and demand balance with number of potential buyers far exceeding the number of sellers. With the Federal Reserve indicating numerous rate hikes over the next 12 months, we could potentially see the demand for homes increase even further.
A “bubble” is more likely to occur with assets that increase in value. What have we seen over the past 2 years... A considerable increase in home values. Here is where the bubble (the housing market) bursts.
In an environment of rising interest rates, advisors often communicate to their clients to hold onto their existing low-rate mortgage (contrary to traditional wisdom). Exchanging a low-rate mortgage with a new, higher-rate mortgage doesn’t make sense, all else equal. By having a fixed rate mortgage people finance their homes with an unchanged rate while also building equity and seeing the home value increase over time. If this were to become a common theme and potential sellers decided otherwise to sell their home and instead stay put, the existing supply could shrink even further. Lance Lambert wrote in his fortune.com article at the end of last year, “We're currently in the middle of the five-year window (2019 through 2023) when the millennials born during that generation's five largest birth years (between 1989 and 1993) will hit the all-important first-time homebuying age of 30” (Lambert). Time will tell if the number of sellers will be able to match the number of buyers.