Bubble- is it coming?
Economists and real estate professionals ruminate on whether to invoke the dreaded B-word and how to react as a hot market continues. Home prices are accelerating, and some markets are now considered overvalued. As home values surge, affordability is rapidly eroding. Are market bubbles starting to percolate in some regions?
Many housing markets are entering a fifth or sixth year of strong sales conditions, with low inventory and continuing high annual price escalations. Add to the mix an extraordinarily long bull market in stocks, and some buyers, agents and brokers are starting to ask whether the residential real estate business is too good. Is a housing bubble in the making? And if so, what can brokers and agents do to mitigate the risk to their clients and to their own real estate businesses?
“We have certainly experienced economic and real estate market bubbles before, which I define as a disconnect between the pricing for products and the underlying fundamentals that should define their values,” says George Ratiu, the National Association of REALTORS® managing director of housing and commercial research. “What happened in the housing market in 2005–2006 could be characterized in similar terms, with a disconnect between prices that people assumed would continue to go up and the underlying fundamentals in the housing market at that time.”
Odds of a Repeat Bubble Are Low
But Ratiu and other economists and real estate analysts are quick to add that the housing market decline that occurred in much of the country between roughly 2005 and 2012, depending on the particular market, was among the severest on record. They view the likelihood of the reoccurrence of an event of similar breadth and magnitude as very small in the foreseeable future.
“As in 2006, today’s home prices are high relative to income and to rent in many markets, but there the similarity ends,” says Frank E. Nothaft, chief economist at Irvine, California-based real estate data and analysis firm CoreLogic. “There are many more differences. For one, interest rates [and capitalization rates] are much lower, so a given income [or rent stream] is consistent with somewhat higher prices. Second, no- and low-doc lending, subprime and no-down-payment lending facilitated by second liens, all of which were common in 2006, have largely vanished from today’s market. Third, the speculative ‘flipping mania’ of 2006 is absent from most metro areas.”
But Local Exceptions Are Possible
Still, while another pervasive Great Recession-like bubble event is viewed as unlikely by many, all real estate is local and that generally applies to bubbles, too. Allan Weiss, founder and CEO of Weiss Analytics LLC, a Natick, Massachusetts-based real estate information and analysis firm, and some other real estate market analysts say that while a major national bubble is unlikely, they do have concerns that bubble-like conditions may be emerging in some markets or property types or price range subsets within those markets.
“When we look at our affordability index, we definitely see evidence of bubbles forming in many markets across the country,” says Daren Blomquist, senior vice president of Irvine, California-based real estate information and analysis firm ATTOM Data Solutions (formerly RealtyTrac). “An index of under 100 for a market means that it is less affordable than it has been in the past. Looking at the most recent quarter, the second quarter of 2017, of the more than 400 counties in our most recent quarterly index, 45 percent of them are below 100, which is definitely more markets than normal.”
How to Recognize a Bubble
It is not easy, but there are ways to recognize bubble conditions in a given market. Among the key factors that economists, analysts, agents and brokers say would highlight the danger of a bubble are:
• Multi-year large annual price increases
• A sudden increase in inventory and/or reduction in sales volume
• Extensive market participation of investors, rather than owner-occupants, as buyers.
• Extensive market participation of relocation buyers from more expensive locations
• Subpar underwriting and appraisal practices
• Sudden shocks to the national economy or local economics of the market
How to React
Communicating with clients about the risk of a bubble is a sensitive issue. Rather than invoke the word “bubble,” a highly charged word likely to frighten buyers, a better approach may be conducting a more nuanced discussion of price risk and sales conditions, says Michelle Gordon, CRS, a Grand Rapids, Michigan-based agent at Distinctive Homes.
With respect to sellers, it may mean advising clients of the possibility of a bubble and advising them to sell at a good price before a possible bubble pops, rather than holding out too long for a “best” price that significantly delays a sale and risks bubble exposure, says Judie Seitz, CRS, a Cincinnati, Ohio-based agent at Comey & Shepherd REALTORS®.
There are also steps that real estate professionals can take to protect their practices. Taking steps to diversify a practice by selling in a wide range of property types and price ranges can reduce the danger of exposure to a downturn in a submarket, says Jeff Dowler, CRS, an agent at Carlsbad, California-based Solutions Real Estate.
Real estate analysts vary in their estimation of which markets might have the greatest risk for bubbles or price corrections. During the first half of 2017, many of the metro areas that bear closest scrutiny tended to be in Florida, especially because of the relatively large price appreciation and elevated levels of investor activity, according to a CoreLogic study, the CoreLogic Market Conditions Indicator.
An ATTOM Data Solutions list of the 20 markets with the lowest affordability indexes in the second quarter of 2017, equating to markets where prices may be overinflated and affordability is out of line with historic norms, has the top spots dominated by Colorado markets, but it also includes Flint, Michigan; Knoxville, Tennessee; and Tarrant County, Texas—which are all among the top 10, says Daren Blomquist, senior vice president of ATTOM Data Solutions (formerly RealtyTrac).
Blomquist notes that markets low on ATTOM Data Solutions’ affordability index list suggest that traditional overvaluation suspects such as New York City and San Francisco are possibly being overtaken by previously more conservative middle-America markets.
By David Tobenkin: a freelance writer in the greater Washington, D.C., area.