Will the housing bubble burst?

Will the housing bubble burst?  Before that question can really be answered, we need to put together a few things that will show where the housing market currently is.  Then, we need to look at the economy and what the effects of the shifting economy may have on the housing market.  Aft that, we can answer the question is the housing bubble going to burst.

As we all know, housing prices have skyrocketed higher.  But, the consumer is beginning to contract due to inflation and interest rates heading higher.  The Federal Reserve has stepped in to combat inflation.  Because of the higher interest rates, and concerns of continually increasing higher interest rates, the stock market has wobbled and fallen from its perch.  The stock market is not the only bubble that has been burst as both crypto currencies and bonds have collapsed.  This leaves the obvious question: What about the bubble in housing; will it pop also?

The reason we had an asset bubble to begin with is the excessive liquidity and stimulus that the Federal Government pushed onto the economy to stave off a dire depression when COVID shut down the world.  Owed to consumers purchasing a surging amount of products & services when the stimulus checks hit, demand pull inflation pushed prices upward.  And, because of the ultra-liquid environment from the Federal Reserve policies, along with near-zero interest rates, assets soared and inflation followed.  There are certainly other factors involved that have driven prices higher.  But, these are some of the biggest contributors.

There are different dynamics that have propelled housing prices higher, however.  Yes, the economy propelled forward despite COVID lockdowns.  And, yes, mortgage rates were at historic lows which allowed many to step into the housing market.  But, despite the big rush into the market, home-ownership participation rates are not very high.  When you consider that fact, and you start to lay out some of the other charts that tell a story, home

There is an interesting breakdown on Realtor.com that shows where the supply & demand of housing really is.^[1]US Housing Supply Gap Widens in 2021  While the article is very useful, I wanted to color this with the entire economic environment we are in to show that the dynamics are going to change with the economy and, what might happen next with the housing market.

Supply & Demand of Housing

I am a purest with classical economics.  I will weigh both supply and demand as well as other factors regarding what may be driving an economic event.

Household Trendline

The first place to look is the number of households and trendline growth:

When looking at what the nation needs for housing, a good start is to look at the number of households the nation is creating.  We are at a record high as the chart above shows.  And, we are starting to drift above trendline which, that means we will need more houses built if there were an equilibrium of houses to households.  There is not.

The US built many new homes over the past several years but, it is not enough to keep up with demand needed.

Supply of homes

First, supply is the more dominant aspect of what is going on in the housing market.

In the 13 years up to the housing bubble collapse in 2008, the United States chronically overbuilt homes.  In the four years just prior to the housing market collapse, the United States built nearly 2x more homes than what was needed.

Of course, the housing market completely collapsed in 2008 & 2009.  What led up to the housing market collapse were the adjustable mortgage rates that were used with individuals who could never truly afford the homes they had just purchased.  That readjustment led to the complete collapse of the housing bubble as individuals defaulted on their mortgages.

Too many buyers for too few supplies

The economy has expanded rapidly since the COVID shutdowns driven by stimulus from the Federal Government and measures taken by the Federal Reserve.  At the same time, COVID drove many individuals to Work From Home (WFH) status, and this got many individuals to evaluate what it was they were interested in for housing.  Adding in an economy that was rapidly expanding, along with mortgage rates at historical lows, the housing market saw its surge in prices as many opted to buy a home.

But, and as mentioned above, there are is not enough supply hitting the market.  Too many buyers stepping into the market where there is too little supply and, this has the makings of significant price increases.

Shortage of Homes Built

Despite this, there was a shortage in total houses built during this time relative to household creation.

Household creation dropped below trendline, as you can see with the blue trendline in the chart above.

From that time forward, however, there was an overall shortage of homes being built.  In fact, the time after the housing bubble burst, some 13.5M total households were created.  But, there were only 7.3M homes built in this same period of time; there is a deficit of some 5.8M homes needed for supply.

Demand for homes

Since the housing bubble, for the post-13 years after, the United States has reverted to a significantly insufficient quantity of homes being built.

According to Realtor.com, we now have a cumulative shortage of home supplies.  Realtor.com believes we have a deficit of some 5.8 million homes here in the United States.

If the United States were to overbuild homes by a factor of 1 million homes more than what we are already building, the undersupply of homes would take some 6 years simply to catch up with actual demand.

Hedge Funds & Home Buying

There is another factor that is driving home prices: Hedge Funds.  Hedge Funds are buying up large supplies of houses and renting them out.  So, while many homebuyers are stepping in to the market, hedge funds are also accumulating houses for rental and investment properties.

Price To Rent Ratio is at all-time High

There is one more thing that needs to be consider: The price-to-rent ratio. Looking at the above chart, if you were to imagine a stationary price throughout time – inflation adjusted, or course – the price to rent ratio is narrowing the profits available for rental units.  This is exceedingly high at rates never before seen, and it may be something that tempers hedge funds from consuming more and more supply simply because they cannot recuperate their costs.  This is something to keep an eye on.

The economy is contracting

As many of my followers know, I have been pointing out a pending contraction in the economy driven by the consumer being taxed at every corner from inflation and now the requisite higher interest rates in order to combat inflation.  In fact, according to the latest University of Michigan Consumer Sentiment Index, the consumer is more downtrodden on the current economic disposition than at any time in the past, including the housing bubble collapse and COVID lockdown.

The fear is that the economy may contract too much leading to a deep and prolonged recession.  That, would translate into lower demand for housing which, that would mean prices would drop.

But, not necessarily.  As mentioned, hedge funds are stepping in to acquire houses as investments and rental properties.  Hedge funds will act as a price support given the magnitude of their accumulation of these holdings.

When you factor in the demand for the limited supply of housing by households wanting to buy the American Dream, any price drops will be met by buyers who’s economic disposition has not suffered much from a potential long and deep recession.

While prices for houses may very well drop due to economic contraction, there will be sufficient buyers to support price.  These buyers are likely to be either households shifting to buy at discounted prices or, the buyers will be hedge funds investing for longterm positioning.

The one piece of the puzzle that is effectively missing is that unlike the housing bubble during the Great Recession, households are not going to be forced to sell and do so at fire-sale prices.

Either way, despite the potential of a long and protracted recession, there will be sufficient buyers for what little supply there is.  Demand will continue to far outpace supply.