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New U.S. Housing Bubble: Experts See Worrying Signs

Analysts monitoring the housing market warn that home prices are on a dangerous trajectory — but that market conditions are very different from those that triggered the previous fallout.

by Andra Hopulele
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3 min. read

“Signs of a Brewing Housing Bubble”

“Is the Real Estate Bubble Growing?”

“What a Real Estate Bubble Would Mean for Homebuyers”

 

These are just a few of the headlines warning Americans of history repeating itself: A new housing crisis — just a few years after the previous one shattered the U.S. market, sending shockwaves through the global economy, as well.

Rapid Home Price Appreciation Doesn’t Necessarily Create a Bubble, but Exuberance Might

In March, the Dallas Fed announced that it saw evidence of home prices “again becoming unhinged from fundamentals.” At the end of the first quarter, median home prices took a real leap, crossing the psychological barrier of $400,000 and reaching a record high of $405,000. Year-over-year, the median listing price went up an incredible 26.5%.

However, as the Dallas Fed report emphasized, rapid home price appreciation in and of itself doesn’t signal a bubble. Rather, factors such as “shifts in disposable income, the cost of credit and access to it, supply disruptions, and rising labor and raw construction materials costs” all contribute to the sustained — but normal — growth in home prices.

Instead, what actually does point to a housing bubble in its incipient stage is the so-called “exuberance” indicator: Prices growing at a rate exceeding what economic fundamentals would justify or home prices increasingly diverging from market fundamentals. Growing exuberance points to abnormal buyer and investor behavior — or housing market fever. And, what these rather telling metaphors describe is a type of irrational behavior on the part of homebuyers —one that’s fueled by the unshakeable belief that home prices will simply continue to go up. The Dallas Fed report explains:

“If many buyers share this belief, purchases arising from a “fear of missing out” can drive up prices and heighten expectations of strong house-price gains. This self-fulfilling mechanism leads to price growth that may become exponential (or explosive), resulting in the housing market becoming progressively misaligned from fundamentals until investors become cautious, policymakers intervene, the flow of money into housing dries up and a housing correction or even a bust occurs.”

If homebuyers and investors believe home prices will continue their fast-paced growth, they become doubly motivated to buy as soon as possible. They rationalize it in this way: First, if prices keep climbing, right now is the cheapest these homes will ever be. Second, the sooner they buy, the more time they’ll have to build their home value. This type of reasoning then creates even stronger demand for a good that’s already in short supply due to market factors like supply bottlenecks and increasing building costs.

A Housing Bubble That Might Not Be a Housing Bubble

Rapidly growing listing prices and a widening divide between home prices and market fundamentals point to the housing market entering the primary expansionary phase of a bubble. What’s more, according to the Dallas Fed’s assessment, “the U.S. housing market has been showing signs of exuberance for more than five consecutive quarters through third quarter 2021.”

This “feverish” state may mark the beginning of a very uncertain stage, with indicators such as price-to-rent ratio and price-to-income ratio sounding some alarm bells.

However, Dallas Fed analysts are also optimistic. They state that the housing market at large, as well as homeowners, are generally in a much better position today than they were in the years before the 2007 bubble, when excessive lending and subprime mortgages almost single-handedly toppled the economy. Moreover, with the memory of those events still fresh in everyone’s mind, buyers are acting with more caution.

Although buyer frenzy points to increasing exuberance and a “market fever” that analysts fear, other indicators show that it’s too early to talk about a bubble. And, with cautious homebuyers and investors operating in a healthier housing market, here’s hoping that the bubble doesn’t grow — and never bursts.

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