The United States could be in the midst of a real estate bubble as great and as potentially destructive as that in 2007. Real estate analyst Mark Hanson thinks U.S. housing prices are 25% to 60% higher than what the market can support.
What’s truly frightening is that Hanson thinks the bottom could fall out of the market at any time. He thinks houses could suddenly revert to their fundamental values without warning. In plain English, it means sky-high housing prices will fall back to Earth and send a lot of speculators to the poor house.
To make things worse, Hanson told Fortune that he thinks the housing market is being propped by what he calls unorthodox capital. What’s more frightening is that Hanson thinks that average people, whom he calls “end-user, shelter buyer” average families, that want a roof over their heads are not buying because of high prices.
“If the end-user, shelter buyer can’t turn on the afterburners for an “extended period of time,” then house prices will “reset” to what the average end-user can buy on a monthly payment basis, which is about 20% to 40% below where house prices are today, regionally speaking,” Hanson wrote in a post at his blog.
Average People can No Longer Afford a Home
“Also on prices, just for fun, if 2006 was a known, nasty bubble, and today, house prices are the same to 20% higher, depending on the region, and incomes are 5% to 10% less, why isn’t this a bigger bubble?” Hanson asked.
Hanson’s thesis is that incomes are now lower, but housing prices are higher than in 2007. The median household income in the United States was $57,936 in 2007 and $53,657 in 2014, according to DepartmentofNumbers.com. The average home in the U.S. cost $247,900 in 2007 and $278,800 in January 2016, according to the U.S. Census Bureau. The average new home in the U.S. cost $365,700 in January 2016.
Hanson is absolutely right. The average American household has less money, yet the average house costs more, which means something has to give. If that wasn’t bad enough, things are worse in some markets; Hanson pointed out that the average home in San Francisco is listed for an amount that’s nearly 10 times the income of the average resident. The average house sold for $1.45 million, while the average salary was $180,000 a year.
Hanson believes that the $1.45 million figure is more than 50% above the housing price a person or couple making $180,000 a year can afford. He estimates that at $778,000. Basically, the only people who can afford houses are the rich or those with access to unorthodox financing, in other words, speculators who can borrow from private investors or access the stock market.
A Real Estate Bubble in a Stagnant Housing Market
One intriguing aspect to this bubble is that it is not being driven by average people taking out risky mortgages like the 2007 mess. Instead, it seems to be driven more by speculation and professional investors.
Institutional investors, such as mortgage real estate investment trusts (MREITs), have purchased hundreds of thousands of houses in some markets, Hanson noted. Wealthy foreigners, including Chinese and Canadians with cash, have also been buying up houses in some markets such as Phoenix.
A sure sign that average Americans are not participating in the new real estate boom is that the number of single family housing starts is still less than half of what it was just 10 years. An estimated 1,691 homes were under construction on March 1, 2006; on Oct. 1, 2015, just 722 houses were under construction.
It looks as if scarcity could be driving high housing prices; the market simply is not meeting the demand for new housing. One explanation for this could be stagflation in the housing market, a lack of demand, and high prices or inflation at the same time.
A big cause of the price bubble is the purchase of houses by investors and persons looking to become landlords and cash in on sky-high rents. Hanson actually thinks that there is also a rent bubble, and he notes that rents in Phoenix are now so high that over 50% of the households in that city cannot afford a two-bedroom apartment.
When will the Housing Bubble Burst?
Most frighteningly, nobody knows when the housing bubble will burst. Since it’s being driven by speculation, the bubble could pop at any time. The most likely scenario will be that the speculators will run out of money, while another will be that they get frightened and start selling.
High prices are already discouraging speculation and house flipping in some markets, Hanson pointed out. He thinks the speculators were buying in anticipation of a recovery that has not come.
This could end the bubble because it is speculation that drives the high prices, which drives more speculation. When the speculators realize that there will be no recovery, they will panic and sell for whatever quick cash they can get.
Two outside events that could burst the bubble would be a sudden selloff by speculators or a sudden rise in interest rates. Hanson expects prices to fall from 15% to 20% by 2017. He also expects the Federal Reserve to launch a new round of quantitative easing and knock down mortgage rates in order to stimulate the economy.
Why a Housing Price Collapse might be a Good Thing
Strangely enough, a collapse in housing prices could be a good thing because it could stimulate the economy. Many more people would buy cheaper houses, thus creating a demand for things like furniture and appliances.
Families could have lower rents and mortgage payments, which would presumably give them more spending power. Hopefully, they would spend this extra money at the grocery store or Amazon, although there’s a good chance a lot of it will go into savings or debt repayment because people have been so spooked by the volatility of the last decade.
One interesting question remains here. Would the Federal Reserve crash the housing market with an interest rate increase just to stimulate the economy? Such an occurrence is well within the realm of possibility, given the fact that the Fed’s low interest rates have led to an uneven recovery.
There is one certainty here. Some sort of housing price collapse is imminent. Like the last crash, it will cause a lot of suffering, but create some interesting opportunities for those with cash.