There is a lot of paranoia about where the housing market is headed, and people worry whether we’re headed down the same path that plunged us into the Great Recession.
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Real estate has appreciated dramatically in recent years, leading some to question whether the housing market is overheating. In the not-too-distant past, the United States witnessed the worst housing crash in recent memory, and those scars are still far too fresh in many people’s minds to move past some skepticism about today’s valuations.

The ghost of the last real estate crash

The year 2008 was a turning point in American real-estate history, as years of loose mortgage standards came to a head and caused a massive housing crash. The financial fallout put the entire global financial system on the brink and triggered a devastating recession from which it took us years to meaningfully recover.

Back then, to save us from certain doom, the Federal Reserve lowered interest rates to near-zero levels — making borrowing cheaper than ever. While this helped us avert economic calamity, low-interest rates have fueled another real-estate boom. While banks have avoided ultra-loose mortgage lending practices that blew up the last bubble, we’ve encouraged a debt-binge with rock-bottom interest rates in recent years.

The last decade of U.S. housing prices resembles a roller coaster that dipped down into oblivion, and then rose like a phoenix, to levels that make many observers uncomfortable.

Flying higher: Interest rates

Now that the economy is finally on solid footing, the Federal Reserve is starting to raise interest rates regularly in an attempt to normalize our central banking policy. But our economy has become accustomed to insanely cheap money that was our life support during the recession. Easing off from near-zero interest rates is going to reverberate through the economy, especially in the real-estate sector.

There is a very direct relationship between interest rates and housing prices. That’s because as interest rates rise, the cost of serving a mortgage also increases, and monthly payments for potential homeowners go up. If interest rates go too high, prices have to adjust to accommodate these new higher payments (read: they go down).  

Many folks are hoping that a solid job market will lure people in buying homes anyway, despite the rising cost of borrowing. Minimally, we can expect slower price increases, as even areas with healthy job markets have housing prices that are becoming extremely detached from average household income.

If you don’t build it, they won’t come

On the other hand, there hasn’t been nearly enough housing built in the past decade to accommodate our growing population. This is due to conservative lending practices after the financial crisis and also because of strict local zoning laws all over the country that discourage building. Today, housing starts are still only 55 percent of the 50-year average.

In fact, starter homes are almost nonexistent in today’s market. Most of the new inventory built caters to higher price points and locks out middle-class buyers from homeownership. If you live on either coast, or in a city with a good economy, chances are you can’t afford a new home.

Naturally, the Trump administration would like to see more construction to increase homeownership and ease our growing housing prices. But finding that sweet spot in public policy that balances financial stability and accessible homeownership is a tough endeavour.

The Trump housing plan

It’s important to remember that we now have a real-estate developer in the White House. That means we could see pro-housing policy come out this presidency as the administration rolls back a lot of the regulations that stand in the way of housing affordability.

The president wants to repeal much of the new regulation that came in the wake of the financial crisis. This could help loosen up lending, but it also threatens to blow up another potentially devastating housing bubble and lead us right back into recession. Rolling back regulations could pave the very same destructive path that led to severe economic pain in the recent past.

Takeaway: Real estate is more volatile than it used to be

Observers of the business cycle will openly admit that it’s hard to call a bubble until it starts to burst. Real estate prices have increased to levels that can call into question the sustainability of today’s prices. But labeling where we’re at now as a bubble is a bold statement that will likely draw significant criticism.

Reading our economic tea leaves is never easy, but it’s safe to say that real-estate prices can only go so much higher before they reach heights that can’t be sustained. If you’re in the market for a new house, make sure the numbers work and consider that in the new economy, real estate is much more volatile than it used to be.

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Header image: Adobe Stock

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Posted 03.07.2017 - 01:35 pm EDT