Is there a Housing Market Bubble? Imminently Followed By a Crash?

Michael Burry wasn’t the only one who made a fortune by shorting subprime mortgages over a decade ago. Another guy who did a similar Big Short was a real estate investor and billionaire called Jeff Greene.

And he believes that just like in the mid-2000s, the current housing market is in a bubble.

There has been a dramatic acceleration in home prices across the US, UK, Australia and even in China over the last 15 months or so. The housing market has incidentally emerged as one of the strongest areas of a world economy that has been reeling under a pandemic-induced recession.

This has led some people (like Greene) to believe that when the post-pandemic surge in demand subsides, a crash in the housing market is imminent aka “bursting of the bubble”.

Yet, there are others who believe this to be just a boom rather than a bubble. They think the soaring house prices (almost 23.4% YoY rise in June 2021) is an effect of the historically-low mortgage rates and imbalance in demand and supply caused due to the pandemic, which is supposedly receding with each passing day.

Translation: The boom is transitory and not heading towards a burst.

Be that as it may, evidence in support of the bubble theory is gradually picking momentum with risks of an imminent housing bubble being reported from across Europe, Canada and Hong Kong recently. Prices are climbing at the fastest pace ever (faster than even the days leading up to the Global Financial Crisis of 2008) causing shortage, bidding wars, fears of a crash and the possibility of housing bubbles in other markets like India.

Let’s find out what’s going on.

Why the Boom/Bubble?

Economists are often very careful while differentiating bubbles from booms. They define a bubble as a situation where the prices of assets are rising faster than the fundamentals (actual worth of the assets) can justify. Often driven by lax financing or overly-optimistic speculation. Plus, a bubble qualifies all the conditions which could lead to a crash, meaning that a pop is inevitable for a bubble to exist. Mere price rise is not a sign of a bubble.

So, let’s look at the so-called fundamentals. What are the factors driving price rises in the housing market currently?

One. The record-low mortgage (lending) rates. Ever since March 2020, central banks around the world have gone on an interest-cutting spree to try and rescue businesses and assuage the economic fallout caused by the pandemic.

As a result, demand for purchase of assets like houses has skyrocketed. But in turn, supply has shrunk on account of logistical ruts caused by the lockdowns. So between more demand and less supply, prices are climbing and climbing with no visible decline in sight until the supply chain crisis is dealt with and rates are stabilised.

Two. A big driver of home prices today is its intrinsic value rather than speculation. Home values are currently driven by low supply and work-from-home models that came into effect due to the pandemic. This has also led to price escalation of real estate in smaller cities as more professionals continue to migrate towards remote locations as permitted by their work.

Three. The perennial fear-of-missing-out. With cost-cutting advantages during the lockdowns giving a filip to personal disposable incomes and the realism unleashed by a deadly pandemic, more people (mostly Millennials and Gen Z) are fearful of missing out on a chance at home ownership. This has intensified the race to buy houses and put more upward pressure on prices eventually leading to low-income shoppers being priced out of the market.

How’s This Different From the 2008 Bubble?

The most striking difference is the extraordinary amount of liquidity in the economy at present. Low interest rates fuel an increased demand for home loans. In addition, all-cash sales in housing now represent 23% of the total transactions (up by 16% from last year) indicating a liquidity boom.

Next difference lies in the mismatch of supply and demand parameters. In the 2008 bubble, overbuilding was a major contributor to the crisis. Whereas now, a supply chain crisis coupled with rising prices in building materials and labour shortages has meant a reduction in the speed of construction.

In hindsight, this also indicates that it is not the lack of homebuyers’ affordability (read: creditworthiness) which is the issue now as it was in 2008. Back then, the ability to buy houses was actually a bubble which popped when the loose credit financing arrangements backing those purchases came to light.

Owing to that, the one glaring difference between then and now is the difficulty in procuring mortgage loans. Thanks to the regulatory séance taking place in the aftermath of the 2008 crisis, lending standards have been tightened since. This means mortgage loans, although available at cheaper rates, are much harder to acquire.

So, the main factors in the current price runup of real estate are essentially lending rate cuts and demand-supply imbalances. Even though the pandemic is evidently sliding into the rear view mirror, the continuing “accommodative monetary policies” adopted by the central banks and persisting supply-chain bottlenecks indicate that it could be a while before the housing prices flatten.

But all in all, the signs point towards a muted risk of housing crash in the coming months. Although it’s promising, it doesn’t mean the housing market is extremely healthy at the moment because homes are still selling and rents are still spiking with bubble-like intensities.

Boom Spillover

With borrowing costs hitting rock-bottom, countries all around the world have begun experiencing housing price surges. Between 2020 and 2021, the rise in housing prices topped 6% in inflation-adjusted terms, the highest rise in seven years.

And the price rise contagion is looming large across the globe. In China, the real estate sector has fallen into shambles after the Evergrande crisis. The low lending rates are contributing towards larger household borrowings and concurrent growth in outstanding mortgages in places like Hong Kong, Canada and Australia.

In some cases, the mandate to strengthen median housing affordability has taken a political turn, like the Canadian PM’s election promise to ban foreign owners from buying houses for two years.

In India, contrary to popular belief that multiple waves of pandemic would adversely affect the property and real estate markets, prices in most cities have increased. With interest rates as low as 6.50%, homebuyers are looking at a narrow window to avail the benefits of government-aided housing schemes like Pradhan Mantri Awaas Yojana and the credit-linked subsidy schemes attached therewith.

Although the appreciation in the prices of new properties has remained marginal owing to a number of factors (hike in prices of construction materials, labour shortage etc.), affordability remains buoyant overall. With reduction in circle rates (minimum rate below which property can’t be bought) and stamp duties in some states, demand for house purchases have maintained steadily in the country.

For an individual, a house is the largest asset that he or she will ever buy. So dealing with volatility in the housing market is a scary prospect for many. That being said, there are too many variables at play in the housing market as of now without any straightforward solutions in sight that compels even Nobel Prize-winning economists to admit:

It’s impossible to know for sure whether something is a bubble.

In any case, with Google searches for “when is the housing market going to crash?” spiking by 2,450%, it seems that regardless of a blip or a bubble, fears of a crash are here to stay.

(Originally published October 16th 2021 in transfin.in)