How likely is a real estate crash?

The US housing market is a hot topic right now. I have seen videos showing lines of people waiting to enter an open day. My loved ones just went through the home buying process and lost homes despite being offered tens of thousands of dollars over the asking price.

This begs the obvious question: is this a real estate bubble, and if/when it is likely to burst? This is a difficult question to answer because no one knows for sure. However, you can look at housing market data and history to get an idea of ​​how things might unfold in the months and years ahead.

The regulations are stricter this time around

I agree that the housing market looks like a bubble right now, and maybe it is a bubble. Housing prices are constantly rising, and it’s fair to wonder how much longer most families will be in the market for a home. But there are some reasons why a “bubble burst” may not be as violent as you think.

Image source: Getty Images.

The real estate crash that began in 2007 is widely considered the most violent in US history and is a benchmark for many watching real estate prices soar today. The 2007 crash is still debated to this day, and while I won’t try to separate all the moving parts, there are significant differences between then and what’s happening now.

First, there were systemic issues in the credit industry that “primed the pump” for what happened in 2007. Lending regulations were much looser then, and banks approved people for mortgages that couldn’t afford the payment. These mortgages were called “subprime” and the percentage of subprime mortgages rose from the average figures in the early 2000s to 18% to 20% between 2004 and 2006.

Ultimately, many of these borrowers were unable to pay their bills, and the resulting spike in foreclosures set off a chain reaction that destroyed housing.

The government has tightened regulations in the wake of the financial crisis, and it is now much more difficult to get a mortgage without having the proper income and credit rating. That’s not to say speculation can’t resurface, but the Dodd-Frank Act was created to prevent these bad lending practices from happening again. Take-out? I don’t know if the housing market will “collapse” without a shock to the banking system, like in 2007 when people quickly started defaulting on their mortgages.

Offer versus demand

Historically, real estate has proven to be very resilient, with median house prices declining in only eight of the last 60 years. Consider the housing crash of 2007; you can see below that from the price spike that led to the crash to about a 30% drop in price to the market low.

Chart showing the 2007 US home price crash and subsequent rebound.

Data on the average sale price of existing homes in the United States by YCharts

In other words, it took years for house prices to fall, and it was arguably the most violent crash in history!

Could the recession cause prices to fall? Of course, and almost every year that median house prices fell, it was during a recession. Mortgage rates are also rising, making it more expensive to finance homes and could help cool buyer demand. At 4.7%, rates are still near multi-decade lows, but have been rising rapidly so far this year.

At the end of the day, housing demand has to fall in order for prices to fall. A recession or a rate hike can have this effect, but no one can know for sure when or to what extent.

One of the unintended consequences of the housing crash of 2007 was that demand fell so quickly that homebuilders virtually closed. The recovery in housing starts took years after the crisis, and today it is estimated that there are about 5 million single-family homes short in the United States.

United States Housing Starts Chart

US housing starts data by YCharts

House prices will likely peak when supply and demand meet in harmony, which does not yet appear to be the case. It’s hard to make this case until I stop encountering crowds of people trying to sneak into an open house. When sellers can no longer refuse buyers offering thousands of dollars above the asking price.

There could be a recession coming and mortgage rates could continue to rise, like buckets of water trying to calm soaring US home prices. Nobody knows for sure what will happen next, but I don’t see enough evidence that prices will dive anytime soon.

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