Will This Become the Pandemic Housing Bubble? 3 Things You Need to Know
We can officially conclude at this point that the Pandemic Housing Boom has ended. But despite tight inventory and low unemployment keeping prices relatively stable for the time being, the Fed’s plan to reset the housing market is beginning to take its toll on home prices.
This has led some to speculate that we may actually be in a housing bubble after all.
As recently as May 2022, the general consensus was that despite the boom being over, homes would continue to appreciate. As recently as July, Zillow was forecasting that home values would climb 7.8% this year. Zillow has now revised its forecast down to 2.4% in August, and then again last week down to 1.4%.
With only a few exceptions, it has only been since the Fed finally elaborated on the details of their plan to reset the housing market last week that the housing bulls finally started to begin talking quietly about the possibility of a major correction being a possibility. Now that the cat’s out of the bag, there is a growing chorus of economists who are now admitting that not only might we see home prices drop, they might drop a lot.
In fact, home prices may end up dropping enough at the national level that we end up with a fairly textbook bubble on our hands. A bubble is generally considered to be a 20% decline or more from the peak. For perspective, the last bubble from 2006-2012 saw peak to trough home prices decline 27%.
But could home prices really decline that much in Northern Colorado?
Here’s the top 3 things you need to know:
#1 – Home prices is many markets throughout the U.S. are significantly overvalued and may fall by as much as 25%
The reality is, local economic fundamentals, including income levels, cannot support the current home prices in much of the country. According to Moody’s Analytics, if a housing market is overvalued by more than 25%, it is considered significantly overvalued. In Q1 2022, 183 of the nation’s largest 413 regional housing markets were significantly overvalued. That number had risen to 210 by the end of Q2 2022. For reference, in Q2 2019 just 3 regional markets were considered significantly overvalued.
So, just how overvalued is the local market as of today? Moody’s puts Greeley at 42.97%, Fort Collins at 34.13%, Boulder at 36.58% and Denver at 42.09%.
Here’s how Moody’s calculates these numbers:
“The Moody’s Analytics housing valuation measure is the percent difference between actual house prices and house prices historically consistent with wages and salaries per capita and construction costs. The price of a house is ultimately determined by the value of the land upon which it resides which is tied to the opportunity cost of the land as measured by wages and salaries, and the cost to build the home. Nationwide, approximately one-half of a home’s value is the land and the other half the structure, but this varies considerably across the country. In San Francisco, for example, the land is far and away the biggest part of the home’s value, while in Des Moines, Iowa, it is the opposite. Our housing valuation measure accounts for these differences.”
Based on all of this, Moody’s revised their estimates last week and now expects home prices to fall 5-10% in significantly overvalued markets... and that’s assuming no recession occurs.
But let’s be honest, the likelihood of that happening is growing slimmer by the hour. In that case, Moody’s is now forecasting a 20-25% price decline for significantly overvalued markets.
Yes, you read that right.
#2 – The Fed has made clear that they are willing to sacrifice the housing market if it allows them to tackle their mandate of fighting inflation
As I discussed last week, for some time now the Fed has been talking about a “reset” of the housing market. It wasn’t until last week that Jerome Powell finally clarified what they mean when they say “reset” and to put it simply, they mean a price correction. The reality is, the Fed is willing to throw the housing market completely under the bus in order to try to rein in inflation. As such, a prolonged inflation battle, which is looking more and more likely as time goes on, will in turn put prolonged downward pressure on the housing market. Historically speaking, significantly overvalued markets are at the highest risk of home price declines during a housing market correction.
Mortgage rates have climbed over 3% in the past year and we are already seeing a tangible drop in prices locally through August:
• Greeley: -1.02%
• Fort Collins: -3.48%
• Boulder: -5.35%
• Denver: -4.28%
As inventory continues to climb, these higher sustained mortgage rates combined with historically high inflation will continue put downward pressure on home prices.
#3 – A housing bubble requires 3 elements, of which we have already hit 2
The textbook definition of a housing bubble requires three things. First, exuberant demand - boosted by speculation - rushes into the housing market. Second, spiked home prices travel well above what incomes can support and reach overvaluation levels. Third, the housing bubble bursts and home prices fall.
A crucial checkpoint lies ahead when the housing stats for September become finalized. Once these can be analyzed, more can be made of the spectacle unfolding before us now.