When will today’s sales price bubble in real estate burst?

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The pandemic’s unpredictable housing market has left real estate professionals wishing for a magic crystal ball. Are we in a bubble? When will home prices stabilize? Thankfully, agents can locate themselves in today’s economic trajectory just by looking to the past — specifically, the Great Recession.

To begin with, 2021’s surging market is hauntingly familiar. Here in California, the statewide average price for low-tier single-family homes was 22% higher than a year earlier in June 2021. Mid- and high-tier single-family home prices grew 23% in the same period.

Throughout the pandemic, home prices rose rapidly thanks to constrained inventory and historically low mortgage interest rates, which the Federal Reserve (the Fed) introduced as the 2020 recession set in.

Despite skyrocketing home prices, job losses stemming from the 2020 recession yet linger. California jobs are still 1.3 million beneath pre-recession levels as of July 2021. And although jobs have been steadily returning throughout 2021, a full recovery is not expected until 2024. This is partly because government aid packages have largely sidestepped job creation.

The mismatch of breakaway home prices and a sluggish jobs recovery is leaving many to wonder: are we in a housing bubble now?

The best way to recognize a bubble is to study the last one. Thus, a little history lesson on real estate fundamentals during the Millennium Boom is in order.

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The Great Recession cycle: boom-bust-rebound

The prevailing narrative among scholars of the Millennium Boom holds that the bust came from changes in credit as well as psychological and social factors. Lenders originated mortgages they knew could not be repaid, and buyers, sellers and investors widely believed prices would only go up. These factors pulled consumers away from the economic fundamentals traditionally underpinning home values, like proximity to jobs and schools.

Bucking the trend, a new working paper from the National Bureau of Economic Research (NBER) finds that the last housing bubble was firmly rooted in economic fundamentals.

This new school of thinking on the Great Recession instead holds that economic fundamentals of local markets shifted during this period. The NBER working paper insists on a boom-bust-rebound cycle to describe this. It defines:

  • 1997 through 2006 as the boom period;
  • 2006 through 2012 as the bust period; and
  • 2012 through 2019 as the rebound period.

The working paper also identifies two elements fueling the boom-bust-rebound cycle:

  • agent and buyer over-optimism; and
  • home foreclosures.

The NBER does acknowledge other economic features like changes in credit supply and speculation in its report. Yet it ultimately concludes that the bubble wasn’t the result of a manic departure from market fundamentals, but a reflection of fundamentals changing in real time.

The crash, they argue, was a feature of over-optimism. So, what does that say about today’s surging market?

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The “uncomfortable feeling” of a booming housing market

The previous housing bubble on today’s housing bubble

Many agents describe a sinking feeling surrounding today’s uncomfortable housing market, which is characterized by outsized demand, restricted inventory and rising prices. Others describe an anxious fear-of-missing-out (FOMO) among trigger-happy buyers. These feelings describe a very real bubble — a change in fundamentals.

Bubbles form when the valuation of real estate increases unsustainably compared to other economic markers such as incomes. Accordingly, today’s home prices have broken away from purchasing power.

While buyer purchasing power experienced an annual increase of 4.3% between January 2020 and January 2021, California home prices rose by nearly triple that rate, registering a 12.1% annual change during the same period. Prices continue to soar while purchasing power struggles to keep pace.

Just as purchasing power became untethered from incomes in the lead-up to the Great Recession, agents are witnessing the underpinnings of value shift. Rather than moving to superstar cities, Californians are increasingly valuing more space and privacy thanks to the pandemic and remote work revolution.

But there are some caveats. The low inventory of homes available for purchase accounts for some of the bubble activity. Single family residential (SFR) new construction starts experienced a meager 1% growth from 2019 in 2020 across the state, while multi-family starts experienced a 9% decrease in 2020 from the previous year. It’s not just social distancing holding builders back.

The eviction moratorium further complicates things. It’s scheduled to expire in California by September 30, 2021. The federal foreclosure moratorium has already expired as of July 2021, yet for many mortgaged homeowners, mortgage forbearance programs remain intact — many expiring starting September 30, 2021.

After these programs expire, evictions, foreclosures and home sales from homeowners with sufficient home equity but lacking the ability to catch up on monthly mortgage payments will commence.

In response, home prices and rents will fall back. Builders are showing cautious optimism as they watch the fallout from the lapsing moratoriums. Nevertheless, California’s inventory will remain low until the moratoriums expire and forced sales resume. Expect to see this inventory boost in 2022.

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The market rebound

2021’s economy and real estate market differs greatly from that of the Great Recession. While today’s shifting priorities have created a veritable bubble, it does not mean the pop will be as loud as the Great Recession’s.

An important tipping point in any bubble occurs when reality drops the hammer on optimism. For instance, second home sales have surged due in no small part to buyer optimism (or pessimism) that the pandemic will change how Californians live in the long term. How far trends like this continue — and whether agents can expect a steady deflation or sudden pop — depends on shifting fundamental needs.

The return of evictions and forced sales also promise some relief from the inventory shortage. While not enough to replete California’s chronically low inventory, the quality of this influx will help steer prices toward a bubble deflation rather than a pop.

Despite the more favorable conditions today compared to the last housing bubble, the economy still has a few more years to go before a meaningful recovery will likely begin. Jobs still need to return, and the housing shortage still needs to catch up with demand. firsttuesday anticipates a recovery to begin around 2024-2025.

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