An article by Russell Price, Senior Economist, Ameriprise Financial

Is the housing market entering another bubble?

The U.S. housing market seems to be once again entering rarefied territory, reaching levels last seen just before the housing bubble burst in 2007. This time around, however, the dynamics of the situation are different. It’s a lack of supply that’s driving prices higher rather than the bubble period’s loose mortgage financing.  

In the downturn that followed the 2003-2007 housing bubble, many builders went out of business and mortgage availability dried up significantly, so much that new home construction fell to levels not seen since World War II. The decline initially made sense given the excess supply of housing created in the run-up. That excess has long since been absorbed; yet new building activity is not keeping up with demand.

Demand is rising – so are prices

Prices for new and existing homes reached new highs in many markets over the last two years, and the threat of higher interest rates, combined with growing consumer confidence, enticed more potential buyers off the fence.

Existing home sales hit a post-recession high of 5.71 million units (on an annualized basis) in March, though this was still sharply below the bubble period peak of 7.26 million (August 2005).

Overall, sales in the first quarter were 6% above last year’s levels, but the pace likely could have been materially higher if not constrained by historically tight supplies of available homes. In March, there was just a 3.8-month supply of existing homes on the market (i.e. it would take approximately 3.8 months to clear all of the homes available for sale at the current sales rate). In a balanced market, the historical norm has been a 6-month supply, according to the National Association of Realtors (NAR).

Tight supply and strong demand is, of course, the recipe for higher prices. The median price for an existing home, at $236,400, was 7% above last year’s levels in the first quarter, according to the NAR. This is a slight acceleration from the average 6% median price gains seen in 2016 and 2015.

The option of renting offers little relief. The U.S. Census Bureau estimates the rental vacancy rate hit a 31-year low of 6.9% in 2016, thus pushing rental rates higher as well. Prices for new homes are also likely to rise further over the intermediate-term.

New home building not keeping up with population growth

1.18 million new housing units (i.e., single family home, town-home, condo, apartment) were built in 2016, according to Census Department figures. Yet, over the last two years, an average of 1.3 million new households were formed (household formation refers to one or more individuals living in a single housing unit). In other words, despite nearly 8 years of housing market recovery, builders are still not keeping up with demographic demand.

Housing market predictions and your portfolio

As of February 2017, the Federal Housing Finance Agency’s House Price Index was 8% above its pre-recession high and 37% above its recession lows.

Some markets, particularly in urban areas and on the coasts, have experienced significant price appreciation, and “bidding wars” are not uncommon. Mortgage rates, meanwhile, are still very low by historical standards which also bodes well for growth in the housing market.

For many people, their home is their single largest investment and an important part of their overall portfolio. Rising home values may affect your intermediate or even long-term investment decisions. To understand how your home fits in with your overall investment strategy, it may be helpful to discuss the matter with your financial advisor.

Source: Housing market predictions