The Four Horsemen of a real estate bubble: Why 2015-2016 is not a bubble market.
I just re-read this post from 2013 and I feel it is appropriate to update it for 2015 as the fundamentals I discuss are virtually the same as they were in 2013 when I first wrote it. In just over four years since the real estate market hit the bottom the bounce back has been dramatic with double digit price appreciation across the board and many areas seeing 50+% jumps. At first, the return to a positive market was a relief from the long grinding crash that lasted for years. Now as we head into the fifth recovery year there is talk of a new bubble. At first look this makes sense; buyers are in bidding wars on homes which are routinely selling over asking price, some at huge margins. Homes sell before the sign even hits the yard and inventory is at lows not seen since the peak of the last boom. In December of 2015 inventory hit an all-time low in the metro area of 1.2 months. Despite the fact that the velocity of the recovery has many people worried, we are not in a new real estate bubble. In a real estate bubble there are four horsemen that tell of a coming crash: Affordability, Rents, Inventory/Vacancy, and Easy Money. To show why there isn’t a bubble about to burst let me illustrate the difference between 2007 and 2015.
The cornerstone of the current market strength is affordability. This factor alone shows the remarkable difference between the real estate bubble of 2007 and the current recovery. Affordability is simply a measure of how many households with median income can afford the mortgage on a median home both nationally and in a given city. Affordability came close to historic highs in 2013. In 2015 we’re still more affordable than most West Coast cities. Why is affordability so high? Three things affect affordability: home prices, interest rates, and median income. At the peak of the market in 2007 homes had largely become unaffordable for many families in America. Prices were 20%-30% less in 2013 than in 2007 and interest rates would have to go up 50% to match the interest rates of 2007. In 2015 the average price was about the same as where it was in the peak in 2007. Anecdotally, my first mortgage in 2006 was 7.25% and my current mortgage is at 3.5%. For a 30-year fixed rate loan of $400,000 in 2006 that means you’d be paying $2,728 a month. How big is the effect of lower interest rates on that same loan today? At 3.5% the monthly payment drops to $1,796 a month, a savings of $932 per month. As I write this interest rates are hovering around 3.75% but there is talk that they will lower again this Summer. Another positive aspect of affordability is that the median household income in Portland is finally rising. This rising wage growth helps keep homes affordable even as prices go up.
The increased rents have also dramatically strengthened the investment market which was the first card to fold in the crash. Not only are investors able to get loans at roughly half the monthly cost of the peak of the market, but rents are up significantly. Lower cost, higher income and increasing market values mean there is little chance that your average investor is going to be at risk of foreclosure today. For many people who currently don’t own homes, buying a house actually saves them money instead of paying continuously increasing monthly rent. Rentals cash flow better for investors and renters are motivated to buy due to relatively low ownership costs.
Portland apartment rents in 2008 averaged $0.86 per square foot but by 2012 they were at $1.03 per square foot, an increase of 20%. Luxury rentals and newer buildings have reported rents from $2.25-$2.85 per square foot. In 2015 Portland led the country with the highest increase in average rent at 12% over one year. Older buildings are routinely charging a $1.50 per square foot with newer buildings being in the $3 to $4 a square foot range in some cases.
At the peak of the market home building was far exceeding actual demand. In cities hit the hardest by the crash they were building two units for every one that was actually needed for the population growth and migration. Vacancy therefore went up to new highs. According to the Census Bureau, housing vacancy hit a high in the West in 2008 when it got to 2.9%. The first quarter of 2013 ended with a vacancy rate of 1.5%, almost half the vacancy we saw at the height of the crash. Even in 2006 it was at an average of 2.1%. The higher vacancy was driven by builders oversupplying the market, and that building frenzy was driven by speculation and easy money. In the apartment market the vacancy rate in Portland dropped in 2015 to an all-time low of 2.9%, despite thousands of new units going on the market and thousands more in the construction pipeline. When you take into account the years of very slow building during the recession, we started to lose inventory that was needed to support the
growth of our market. Even today building is not keeping up with the needed units and due to our restrictive development policies in Oregon and Portland it’s not looking to get any easier to build. In 2015 the inventory of existing homes for sale hit an all-time low of 1.2 months in December and we’re still under 2 months in the metro area. With inventory this low, prices are looking to continue to rise in Portland.
If you or someone you know has bought or refinanced a home in the last 5 years, you are aware that the process is significantly more cumbersome than in 2004-2006. Gone are the exotic loans and the no income verification loans. In today’s market lenders want to know everything about a borrower’s credit and all of their finances. Gone also are the days of zero down investment loans on properties with no income or not enough income to even cover the mortgage. While the rates are low on today’s loans, buyers need to have real money down and a clear ability to afford their mortgage. These stringent requirements for borrowers ensure that the market growth is sustainable and that homeowners and investors alike can afford to make the payments. In 2006 this wasn’t always the case, and if an investor has no money invested in a property, and the market goes south, there is no motivation to try to make it through the hard times. Simply put, borrowers in 2013 have to actually be qualified and able to afford their loans. Fast-forward to 2015 and loan qualifications are still very strict. You might also be surprised to learn that 30% of the purchases have been all cash in the last few years. If there’s no mortgage, there’s no risk of foreclosure, and that gives a lot of stability to the market.
The intent of this article is to highlight the major differences between the bubble market of 2006, the recovering market of 2013, and the most recent data from 2015. Today’s market is fundamentally more sustainable across the board. Affordability is very high relative to the rest of the west coast. Rents are up, inventory and vacancy is down and easy money is gone. These four horsemen of a real estate bubble are the factors you need to consider when looking at the health of the real estate market. Right now all the indicators are pointing to a healthy and appreciating market.