Tuesday, July 23, 2013

Is There a Housing Market Bubble?

Prices of houses are on the rise and it is a great thing.  Americans lost about $8 trillion in net worth in their homes between 2008 and 2010.  Americans that were underwater on their mortgages are resurfacing with positive equity.  This allows them to either sell the home or refinance at a lower rate.

With the increase in home prices, the question of housing "bubbles" has also resurfaced.  Is the housing recovery sustainable or are we having another housing bubble that will burst?

In order to to qualify as a bubble there must me a capacity to "burst".  A bubble bursts when a lot of people decide to sell at the same time, and they need or want to do it quickly.  To get a bubble to burst there must be a massive imbalance between supply and demand.  Either the supply increases too much, buyer demand drops off precipitously or both happen simultaneously. 

Here are some conditions that could cause a significant price decline in house prices:

1.  There is a massive increase in sellers putting their homes on the market at the same time
     and are determined to sell quickly.
     .  This is unlikely unless we have a big recession that leads to massive layoffs again.

2.  Home builders grossly overbuild and have to cut prices to stay solvent.

     .  Currently, home builders can not get enough loans to overbuild the market.    
     .  While new home construction is increasing, it is still historically low.

3.  There is a massive decrease in the number of buyers.

      .  Dodd-Frank is limiting the number of people who can buy homes, but American enthusiasm for
         owning a home is gaining each month.
      .  Mortgage rates are unlikely to go high enough to significantly dampen demand.
      .  Eliminating the mortgage interest deduction would not impact many American families, as they
         do not benefit from this tax deductions and don't make buying decision for this reason.

It appears there is no cause for concern about a bubble forming in home prices.  We are presently witnessing a quick rebound from the low prices that were a result of the massive sell-off from 2008-2011.  Low inventories in many communities are driving the prices higher.  It will likely be years before the home building industry gets access to sufficient capital to overbuild.  Today's buyers are putting more cash into their purchase and owners with low leverage are less likely to be forced to sell to avoid foreclosure.  However, as in any market. the housing market could have the unexpected change that nobody could predict.  If consumers develop a sudden aversion to stainless steel appliances and not buy any homes unless they have harvest gold or avocado green instead, all bets are off for the housing market. 


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