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The Next Housing Bubble is Not Here

house in a bubble
With increasing home prices and spiking interest rates — which still sit at an extremely low sub-5 percent level — it’s easy to see why some think the next Housing Bubble is upon us.

But as some industry insiders told loans.org that this belief couldn’t be further from the truth.

Defining a Housing Bubble

Even though the phrase “Housing Bubble” still gets tossed around often, it is rarely defined in a straightforward fashion for the average person to understand.

The actual definition of a Housing Bubble must be established before any further discussion of it can resume.

According to Redfin Real Estate Economist Ellen Haberle, a housing bubble is defined as an unsustainable rise in real estate prices which will eventually lead to a market correction.

As America remembers, in the lead up to the 2007 Financial Crisis, lenders gave mortgage loans to subprime borrowers. Giving mortgage loans to a substantial portion of the population that couldn’t sustain payments over a long period of time ended up popping the Housing Bubble, as did the incessant increases in real estate thanks to speculation.

With the country and world economy now recovering after years of sluggish growth, it would be wise to keep an eye out for a repeat of the very same Housing Bubble.

As bad luck would have it, Haberle believes that Washington DC, Los Angeles, San Diego, and San Francisco may be entering bubble territory, but fortunately the country as a whole is not.

Rising Rates and Rising Prices

Bubble or no bubble, interest rates are rising. However, rising is much different than soaring. The latter implies dramatic increases over a short period of time. Since interest rates are still below 5 percent, they are clearly not soaring, as relatively recent historical trends have shown us that interest rates often hover between 6 and 9 percent.

In order to verify why the nation is not experiencing the next Housing Bubble, we must examine why interest rates are rising.

“Mortgage rates tend to track US 10-year Treasury bond yields closely, and bond yields have been rising since about May 2013,” said Haberle. “Since US Treasury notes are considered the safest investment, and thus provide low yields, mortgage originators must provide a slightly higher return to attract investors. Furthermore, the Federal Reserve since 2008 has maintained a very loose monetary policy stance which has helped keep mortgage rates near historical lows.”

Haberle also said that the Federal Reserve triggered a surge in 30-year fixed interest rates from 3.81 percent in late May to 4.46 percent in late June after announcing that it will slow its purchasing of bonds since the economy was recovering. However, 30-year fixed mortgage rates have averaged near 6.75 percent since 1990, meaning that present rates are still low compared to historical standards.

“Home prices have increased sharply as homebuyers, who now feel confident enough in the US housing market to buy a home, are meeting tight inventory conditions,” said Haberle.

“Many homeowners are still underwater on their homes and are waiting for prices to rise before they list.  Additionally, new home building was crippled after the onset of the housing crisis, so limited home construction has occurred since 2008 despite a US population increase of about 10 million during that time.”

Since home construction takes longer to achieve than home demand, there is a tight inventory in comparison to the number of buyers. As a result, home prices increase in accordance with simple supply and demand.

Aside from new and returning buyers, there is another party that has been purchasing homes, albeit without borrowing mortgage loans.

A Global Customer Base

Foreign investment in America is nothing new.

Globalization was once a buzzword but now is the norm, and just as wealthy Americans can invest in foreign countries, so too can foreigners invest in America.

“Over the last few years, we have seen increased interest from foreign buyers in the US real estate market, particularly from Canadian, Chinese, and Mexican nationals,” said Haberle.

“These foreign buyers have flocked to the US market because they see it as a secure and profitable place to invest their money. Furthermore, the relative strength of some foreign currencies against the US dollar means that foreign investor money can stretch further here.”

Many foreign investors are also able to pay cash for properties — an ability that most middle class Americans can only dream about. The purchases that foreign buyers make in the US not only stimulate the economy but also intensify home markets in such high priced areas as California’s Los Angeles, San Francisco, and Orange County. While these areas certainly have their share of wealthy investors who are US citizens, foreign demand only further drives up prices and keeps the available inventory in these markets low.

In effect, it is similar to a crowded store with prized items on Black Friday. Many customers will be there, all for those same items, making it more and more unlikely for an individual to get their hands on it. Just imagine if stores were then able to give those items to the highest bidder. It’s supply and demand at its finest (or worst), and that’s how the housing market is currently operating — but this pattern is not exclusive to California.

Ronald Krongold, Managing Partner at Gold Krown Financial, told loans.org that the housing market in Miami is attracting international buyers from South America, Europe, and Asia. He feels that this popularity is not only due to Florida’s famously desired weather, but also because real estate prices are undervalued in Miami compared to major international cities such as Hong Kong and London.

“The Miami market is rebounding and surpassing all expectations because it has arrived on the map as a global city,” said Krongold. “We are seeing record-breaking sales that were unimaginable prior to the recession, and the city has surely not reached its limit.”

Foreign investors look to US housing markets in order to put their wealth into safe investments and also to purchase income-generating properties. Despite the constant talk in the media about growing government power and the ongoing Surveillance Scandal prompted by Edward Snowden, the US government is not in a position to be toppled easily or quickly.

Unfortunately, the same cannot be said about other countries in the world, many of which are far less economically and politically stable. In many of these countries, democratic elections are not always respected and bank accounts can be readily looted by corrupt government authorities. Hence the need for many in the developing world to put their money far from their own home governments’ reaches.

Even though interest rates are rising, Krongold thinks that this will not stop foreigners who purchase real estate with all-cash payments. After all, interest rates only apply to mortgage loan borrowers, not investors who arrive with hundreds of thousands of dollars ready for making quick land purchases. However, rising interest rates will make it more difficult for local buyers to enter into the housing market.

But foreign property moguls have another advantage over the local players. Foreign investors are less likely to “panic sell” in the event of an economic or global crisis. This is because, despite what may be happening in a US real estate market, the ownership of land in the relative safety and stability of America still holds value compared to liquidating that purchase into cash. Should a foreign investor liquidate their land holdings in America, the money would likely be wired back to their home country, where it would once again be vulnerable to problems not found in America.

Chinese buyers in particular tend to purchase real estate in order to move wealth out of their country and possibly blaze a trail to eventually move their families to America as well. Despite the fanfare over Chinese investors making land purchases, they still account for a small amount of the market’s active buyers.

Interestingly, while local first-time homebuyers may see these foreign investors as an obstacle preventing them from finding an affordable property, some feel these foreign investors are the true victims.

Vernon Martin, Principal of American Property Research, told us that many Chinese are being unfairly courted to invest in the US, rather than doing so of their own volition.

“As for the Chinese, a whole industry has emerged to find and trap the Chinese nouveau riche,” said Martin. “There are firms on both sides of the Pacific which are paid fees, sometimes as high as $125,000, for finding these investors. There are numerous seminars on how to market U.S. real estate to Chinese buyers, and the emphasis seems to be not so much on helping Chinese investors but on selling properties for which there is a lack of American buyers. The smart Chinese investors still succeed in finding quality real estate, but there are some suckers, too, particularly those attracted to real estate projects sponsored by the EB-5 visa program.”

Under this program, foreign investors can obtain green cards so long as they invest $500,000 to $1,000,000 in the US economy. However, investors are required to create or preserve at least 10 jobs through their investments. These jobs must exclude the investor and his or her immediate family.

Future Threat

Even though the government has a program to allow foreign investors into the country, and the economy is seemingly rebounding, there remains the possibility that a future bubble may once again develop.

Martin told loans.org that one of the precursors to a housing bubble is the buildup of unsold housing inventory as well as falling residential land prices. However, since current demand for property is high, there is no buildup of unsold housing inventory.

Adam Thurgood, Financial Advisor and partner at HighTower Advisors, told loans.org that, at this point, the nation is not in the midst of a housing bubble. The market is still bouncing off depressed levels, not inching towards a peak. He said that prices in Las Vegas, where his company operates, would need to rise by over 161 percent to return to peak price levels.

Thurgood believes that despite rising interest rates, housing is still affordable for the average American. Should housing prices increase at double-digit rates though, then a housing bubble will begin to inflate.

“We shouldn’t be worried when smart investors are picking up property,” said Thurgood.  “It is when the average Joe starts buying in bulk that you need to run for the exits and I just don’t think we are even close to being there yet.”

However, he is worried that the number of home buyers with variable interest rate home loans is rising. This could prove disastrous since rates are expected to move higher in the coming years. As a result, adjustable rate mortgage (ARM) loan borrowers could be facing higher monthly payments that will put additional strain on their financial lives. Thurgood wants the government to pressure mortgage loan lenders to be more conservative in their qualifications for ARMs.

Even though the government may have its hands full with ongoing crises, ignoring housing may prove to be fatal to any economic gains made if indeed a Housing Bubble is just a few interest rate percentile points away from inflating. And hopefully both lenders and borrowers have learned their lessons since the last bubble’s catastrophic explosion.