by Brian J. Curry, MAI, SRA, CRE, FRICS, Executive Managing Director
Are we entering another housing bubble? Most housing supply and demand fundamentals remain favorable. However, there is growing concern that the rapid and consistent increase in home prices demonstrated over the past several years is not sustainable. In fact, some markets may already be overpriced relative to those factors that gauge housing demand, primarily buyer purchasing power.
After a robust 2013 and moderation in 2014, many housing industry experts predicted home price stabilization in 2015-16. However, home prices continue to increase well into 2016, with CoreLogic reporting a 5.56 percent year-over-year increase in April 2016.
CoreLogic Home Price Index
Employment growth and low unemployment have contributed to strong housing demand. Low levels of new and resale inventory are also part of the home appreciation equation. However, job growth and an improving economy were already a part of home price stabilization projections.
The main reason for the increasing housing demand is interest rates. Most experts forecasted moderate increases in home mortgage interest rates in 2015 and certainly by June 2016. However, mortgage interest rates are currently near their lowest levels since the Great Recession. At 3.60 percent, the average 30-year fixed rate is only slightly higher than the low of 3.35 percent posted in December 2012.
Higher home prices and slightly higher mortgage interest rates resulted in decreasing affordability levels in 2013-14. However, lower interest rates in 2015-16 provided for some stabilization in affordability levels.
Existing Home Affordability Index
Although home prices have been increasing, interest rates have been decreasing. As a result, the median housing payment to income ratio, which was increasing in 2013-14, has stabilized while home prices continue their upward climb.
Median Housing Payment to Income Ratio
Source: John Burns Real Estate Consulting
Job growth has been strong with nearly 13 million new jobs since the Great Recession. Wage growth, on the other hand, has been very low or flat. Nominal wage growth (wages adjusted for inflation) is currently about 2.0 percent, well below the Fed’s target of 3.5 to 4.0 percent.
Wage Growth Since 1985
The result is an increasing gap between home price and income, now approaching levels not posted since the sub-prime meltdown, housing downturn, and ensuing recession. The latest housing price to income trend is not a good sign for housing. Some have suggested the wider gap is the new normal. That suggestion echoes similar discussions in 2004-2006, and the subsequent housing downturn is now part of history. Certainly households with multiple incomes have advanced the ability for housing cost to take up a larger portion of living expenses. However, household income is simply not keeping pace with home price appreciation.
The Housing-Income Disconnect
Index, January 2000=100
What must happen to close the gap?
Housing market conditions vary significantly by region. Some select markets may already be overpriced while others still have more room for price inflation. Moderate appreciation is normally deemed an indication of a healthy housing market. However, the gap between income and home price is widening. A rise in interest rates would help put the brakes on home price appreciation, and wages must increase to accommodate household purchasing power. The Chair of the Federal Reserve is in a predicament; Yellen must keep rates low to spur economic, employment, and wage growth. At the same time, the historically low interest rates are the major contributing factor to home price appreciation. Wage growth typically follows low unemployment. Hence, wage growth should be forthcoming. Absent an increase in interest rates and robust wage growth, another housing bubble and subsequent correction is in the making. This uncertainty continues to weigh heavily on the minds of capital investors, developers, builders, and lenders active in the housing industry.
Brian J. Curry, MAI, SRA, CRE, FRICS is Executive Managing Director and National Practice Leader of the Residential Development Practice Group with Cushman & Wakefield’s Valuation & Advisory.