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Are We in a Housing Bubble? A Shocking Discovery...

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Many experts are saying that, as I write this - March 15, 2021, that we are in a housing bubble. Inventory is at an all-time low and and on top of that, mortgage interest rates are low which results in high demand for housing. The two combined - lack of inventory and high demand due to low interest rates - results in house prices being an all-time high.

House Prices Are Too High?

The following graph shows this to be true:

With 1990 as the basis - i.e., index 100, this graph shows US home prices back in 2006 peaked at 240 index or 2.4 times home prices of 1990. It has now reached all-time high of 306 or basically 3 times home prices of 1990.

However, we need to take into account inflation. Yup - that nasty tendency of the US dollar to lose value over time. Below is the inflation-adjusted graph:

House Prices Are NOT That High (With Inflation)

As can be seen from the above graph, as of beginning of 2021, home prices is around 1.6 times 1990 home prices, when adjusted for inflation.

This is the reason why it is NOT good to buy a house cash or without getting a mortgage. In real, inflation adjusted dollars, you only make a 60% return from appreciation over a 30-year period from 1990 to 2020! The stock market has a higher return than that. 

And talking about buying a house with a mortgage, the reality is - most people buy houses with a mortgage. The price of the house is secondary in importance to whether one can afford the monthly mortgage payments.

A "Shocking" Discovery

Back in 1990, the 30-year fixed interest rate is 9.89% and in 2021, the mortgage interest rate is less than 3%. In other words, even though home prices today are more expensive compared to the same house 30 years ago, the interest rates one pays is way lower. So what's the impact of this on mortgage payments? Assuming 5% downpayment and 80% of the house payment being on mortgage principal and interest (and 20% for taxes and insurance), below is a graph that was quite shocking.

In other words, the average house payment in the US today is about the same (if not slightly lower) than 30 years ago! That's right - even with higher home prices today, the fact that interest rates have been cut by almost 2/3rds result in no increase in mortgage payments!

On hindsight, the graph above, although "shocking" makes a LOT of sense. Ultimately, the price of homes will go up only up to a certain limit and that limit is affordability. Can the median household income afford the median priced home...not in terms of price but in terms of the house payment? If not, the tendency of home prices is to go down to become more affordable.

Real wages when adjusted for inflation (as the graph below shows) has kept up with inflation from 1990 onwards (although it trended downwards from the 1970s up to 1995).

So are we in a housing bubble?

At the height of the housing bubble of 2006, the mortgage payment is 17% more than the mortgage payment back in 1990 after adjusting for inflation and even after the lower interest rate we had at that time compared to 1990. 

In other words, the average mortgage payment at that time exceeded what people could afford and grew way faster than inflation. It was due for a correction because clearly it was not sustainable. 

What about now?

Right now, as of March 15, 2021, the US median household income can still afford the median mortgage payment so the quick answer to the question is NO we're not in a housing bubble as a country. Of course this is different in different areas of the country. San Francisco is 25% more expensive in terms of house payments today vs 30 years ago - although one has to factor in the fact that the technology is a much bigger employer in San Francisco today than in 1990. We need to look into the growth of wages adjusted for inflation in San Francisco to see if the 25% growth in house payment is still affordable. If it is,  then San Francisco is not in a housing bubble as well.

But House Prices Could Still Drop

There are several factors that could result, not necessarily in a housing market crash but in reduction in home prices. Here are some of them:

1. What's the effect of lifting the foreclosure moratorium on home prices? Most likely, there will be a jump in foreclosures but will the increase be significant enough to result in lower home prices?

2. What's the effect of the recent $1.9 Trillion stimulus of President Biden on inflation? If the CPI (Consumer Price Index) rises faster than wages, then affordability will drop which could lead to home price declines.

On the flip side, the stimulus should help some home owners who are behind on their mortgage to catch up and avoid foreclosure altogether.

3. What about interest rates? An increase in interest rates will hurt home prices as monthly mortgage payments will increase.

4. The most important factor is the unemployment rate. We don't quite "feel" 100% of the effects of the higher unemployment due to the Covid lockdown yet because of the stimulus money. But 6-12 months after it runs out, we will likely see downward pressure on home prices.

In conclusion, we are not in a housing bubble similar to 2006-07 since home prices, more specifically, home mortgage payment is still affordable. However, we might see home prices decrease slightly in the next 6-12 months.

What's your opinion on this? Do you think home prices will decrease or increase in the next 6-12 months?

Thanks to John Wake's analysis on home prices and mortgage payments in his website - RealEstateDecoded.com.


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