Is There a Real Estate Bubble or Not?

The b-word has been used a lot in recent conversations about U.S. real estate, and it is easy to see why. Average home prices in a number of American cities have risen to ludicrous levels, and they continue to rise—the average single family home in the Denver area sold for $415,495 in May 2015, a 4% rise over April’s price and a 12% increase over the 2014 level, The Denver Post reported.

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Home prices in Denver and Dallas are actually exceeding the record highs reached during the great real estate bubble in the last decade, the S&P Shiller National Home Index indicates. Denver now has the fastest growing house prices in the nation, according to The Post.

Is It a Bubble or a Shortage?

Okay, the prices are high and the speculators are circling, but is it a bubble? Maybe not, and here is why. Even though prices were up, actual sales of homes in the Denver area were 13% lower than they were in May 2015, according to The Post. In other words, the prices are increasing even though the demand for housing seems to be falling.

That would indicate a shortage of housing, not a stronger market. Realtors and others interviewed by The Post blamed the high prices on a low supply of homes, not a strong market. Contrary to popular belief, a shortage that drives high prices does not indicate a strong market; it simply indicates that those who are willing to buy are paying more.

The phenomenon seems to be occurring nationwide too; the number of new mortgage applications in the United States fell by three percent in the last week of May, according to CNBC’s Realty Check. The number of homes for sale and the number of people interested in buying a home is declining.

It’s a Seller’s Market but Nobody’s Selling

Not surprisingly, home flippers are having a much harder time making money in the Denver area, The Post reported. The flippers cannot make any money because they cannot find any homes to buy.

The major cause of the house shortage is that homeowners simply do not seem willing to sell, CNN Money reported. One reason for this is that homeowners fear that they will not be able to find a comparable place to buy for a reasonable price if they succeed in selling. News stories about shortages of affordable rentals in cities like Denver are certainly stoking this fear.

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There are also a lot of homeowners that are still underwater in their mortgages because of the last retail bust. Last year RealtyTrac reported that around 1.8 million homes nationwide are considered “seriously underwater.” Being seriously underwater means that a home is mortgaged for 125% of its value or more. That means a lot of homeowners could not make any money even selling at the ridiculously high prices.

Why Aren’t Builders Building?

A major reason for the shortage and the high prices is that new homes are simply not being constructed. CNN Money reported that only around 700,000 new homes were built in the United States in 2014; in the average year, around one million new homes are built. That translates into a shortage of around 300,000 or more homes in the market and increases the price of existing houses.

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Homes are not being built because of strict lending standards, David Crowe, the chief economist at the National Association of Home Builders, told CNN. Contractors are not building because large numbers of people simply cannot get a mortgage under the new rules.

The Mortgage Shortage

The lack of mortgage financing could bring the current real estate boom to a screeching halt. Two other reasons why mortgage financing is scarce are:

• Income inequality. Large numbers of Americans simply lack the money and credit ratings to qualify for a mortgage. One reason for this is the high real estate prices; last year HSH.com estimated that there are 13 majorS. cities where the average family cannot afford to buy a home.

 

• Another is the uneven nature of the recovery from which only certain segments of the population, mostly investors and the upper class, are benefiting. The Washington Post estimated that the average income in 81% of the counties in the United States was lower in 2013 than it was in 1999.

• Geography seems to support this contention; housing prices are increasing fastest in affluent areas with booming industries that create lots of upper class jobs in fields like finance and technology. This includes Dallas, Denver, Seattle, New York and the San Francisco Bay area.

 

• Home prices are lowest in blue collar communities like Forest Park, Ohio, where the average house is listed for $120,247; Scranton, Pennsylvania, where the average home sells for $118,424; and Kankakee, Illinois, where the average home sells for $119,180. The cheapest average house price in the U.S. was found in the capitol of the Rustbelt, Cleveland, Ohio, where the average home listed for $64,993.

• It looks as if the average American family is now being given a very stark choice: housing or jobs. One has to wonder how long this state of affairs can continue.

 

• The artificially low mortgage interest rates created by the Federal Reserve’s quantitative easing policies simply make it unprofitable to issue a lot of mortgages. At interest rates of 3.5% to 4%, mortgage lenders simply cannot make money.

 

• This might be why money is flowing into some other areas of lending, including peer to peer, consumer loans and car loans, where lenders can charge higher interest rates. Bankers and investors simply cannot make money in mortgages. The money is not there, so the loans are not there either.

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Wellington Denahan, the Chairman and CEO of mortgage real estate investment trust Annaly Capital (NYSE: NLY), even went so far as to blame the Fed’s interest rate policies for income inequality. Denahan thinks quantitative easing will lead to deflation and drive down prices by increasing the level of debt. Annaly, which makes its money by repackaging mortgages and selling them to investors, has been struggling because of a lack of new mortgages.

The Housing Shortage

Instead of a housing bubble, we might be facing a housing shortage. The housing shortage is driven by a vicious cycle: People cannot afford to buy homes, so no houses are built. This drives up the price of existing housing stock and further contracts the market because fewer people are buying as costs increase.

One has to wonder how long this bizarre real estate market can continue. It might last a lot longer than you might imagine. Real estate prices in Australia have been rising since the turn of the millennium.

The real estate market, it seems, is now more insane than the stock market. Stocks are now a far better investment than a home in today’s America.