Is There Another Real Estate Market Bubble Developing?

According to David Girling, President of the Newport Beach Association of Realtors and a financial expert, feels that four of five economic indicators portend a correction, but not of the magnitude that was seen in 2006-2007. 

In an article published this month in OC Realtor, David comments that "Any significant

increase in interest rates will have an impact on our real estate market, most notably on buyer purchasing power."  Let's take a look at the five indicators that may signal price corrections and see if there is any validity to this talk of a real estate bubble:

Housing Affordability

Rising home prices have impacted housing affordability, and affordability has been decreasing across the country since the beginning of the year. In California, the percentage of home buyers who could afford to purchase a median-priced, existing, single family home in the second quarter of 2015 was at 30 percent according to the California Association of

REALTORS® (C.A.R.) Housing Affordability Index (HAl). The HAl peaked at 56 percent at the beginning of 2012. The median price for a home in California has doubled since February 2009, while the median price for a home in Orange County has risen 62 percent in that same period (see Figure 1). Wages have not kept pace, so fewer people have been able to afford to buy as prices have climbed. Housing affordability is one of the most critical barometers of the health of our real estate markets. David concludes that unless wages keep pace, a correction in prices may be warranted. 

Housing Inventory Levels
Housing inventory levels remain extremely low. David offers a few of the reasons why:

1. Higher property taxes for any comparable property purchased.
2. Fear of not finding replacement housing because of high rents.
3. The negative equity many homeowners still can y.
4. Reluctance to give up favorable interest rates from 2013 even though today's rates are still low.
5. The challenges smaller builders are experiencing in procuring loans.
6. The capital gains taxes that many homeowners will face if they sell (This may be the most important reason.)

All six of these reasons affect inventory levels; but in the aggregate, the result David feels may be low inventory levels for extended period of time. As long as demand remains strong and supply low, home prices will be supported at their present rate.

Foreign Investment and the Stock Market
David comments that during the week of August 25, the stock market suffered its worst losses since 2010, falling more than one thousand points for the week (a 5.8 percent drop). While the market recovered some, as of August 31, it was still down 7.3 percent since the beginning of 2015. In large part, the drop was the result of the devaluation of the Chinese currency (yuan), combined with weak economic growth in China. This relationship between a drop in the U S. stock market and China's economic woes should confirm that ours is a global economy. As we know, foreign investment in U S. real estate and other factors, such as low interest rates, have buoyed home prices. Further, a strong dollar makes U.S. real estate seem more expensive. Many foreign investors- especially Chinese investors- are buying real estate in the United States because it is a safe haven; however, it will be important to see how recent developments affect foreign investment in U S. real estate going forward, especially when US. real estate appears to be more expensive.

The conclusion he draws here is that a strong dollar, combined with losses in the equity markets, may cause foreign investment to slow. How long will the need for safety override these factors? A slowdown in foreign investment would certainly create softness in home prices.

2006-2007 Peak Price Levels
Some experts think that, once housing prices return to the peak levels of 2006-2007, we may be close to another bubble. Driven by low interest rates, limited inventory, good buyer demand, and improved job markets, prices in some areas of California are approaching
those peak levels. However, in May, the California median home price was more than 18 percent below peak levels. Orange County median prices, although closer, are 7 percent from peak levels. As of June 30, Newport Beach prices are 11 percent off peak levels
according to the Newport Beach Home Price Index shown on the right. 

As prices approach peak levels in some areas, some experts believe that those areas will develop mini bubbles. The market may very well be in store for a correction, especially since many of the fundamentals that existed in 2006-2007 have not corrected to peak levels.

Interest Rates

Along with foreign investment in U.S. real estate, low interest rates have supported real estate prices. For the better part of two years, the Fed has been talking about an increase in interest rates. Easier said than done! Any significant increase in interest rates will have an impact on our real estate market, most notably on buyer purchasing power. Mathematically, for a given increase in rates, payments will be higher and, thus, purchasers will be able to afford less.

The conclusion to draw here according to David is that higher interest rates will further reduce housing afford ability and may lead to a price correction.

The Bottom Line
A "real estate bubble"? Some analysts will tell you that we are not nearing a real estate
market correction. One camp references studies that show we still have a few years to run in this current real estate cycle before there is a correction. Others will say a bubble is just around the corner. Four of the five economic indicators discussed above suggest a correction in housing prices, but nothing like the crash we experienced in 2006-2007.

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