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May 3, 2021, 9:36 a.m. EDT

Is the U.S. housing market heading for a crash? Here’s what the experts say

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Jacob Passy

The housing market is hot — but is it too hot?

That’s the question a lot of Americans appear to be asking themselves. Data from Google /zigman2/quotes/202490156/composite GOOGL +2.21% underscore the concerns that many people have about the state of the market.

Searches for the phrase, “When is the housing market going to crash,” are up 2,450% over the past month. Similarly, Americans are searching in droves for explanations about why the housing market is so hot and why home prices are rising, Google reported.

Americans’ concerns are perhaps a natural by-product of today’s extremely competitive market, economists said. “If we see prices rising as quickly as we have, for some people it might spark some memories of the last time around,” Matthew Speakman, an economist with Zillow /zigman2/quotes/205077794/composite ZG +4.69% /zigman2/quotes/204413973/composite Z +4.46% , said.

“After robust gains over the past five years, the nationwide nominal house price index is now 40% above its 2012 low-point and 4% above the peak reached in 2006. If 2006 was a historic bubble, then current price levels should be looked at more closely,” according to J.P. Morgan Research.

For some, today’s real-estate market might feel eerily similar to the market conditions that preceded the Great Recession. Given that the last housing boom triggered a global economic meltdown, these concerns are certainly understandable. But housing experts argue that Americans don’t need to get themselves too worked up — yet.

Fitch estimates that national home prices are approximately 5.5% overvalued. “Slowing employment recovery and still-high unemployment levels are not supportive of long-term sustainable price growth,” wrote Suzanne Mistretta, senior director at Fitch Ratings, in a recent research note.

And even the more optimistic forecasts from within the industry don’t see current prices lasting.

“We’re not going to see a crash in the housing market, but we are expecting some cooling on the really unsustainable growth rates that we saw, particularly in 2020,” said Robert Dietz, chief economist at the National Association of Home Builders. “When home prices are growing faster than incomes, ultimately that is an unsustainable trend.”

What’s going on in the housing market?

A year ago, when COVID-19 cases first skyrocketed across the U.S., the home-buying market came to a screeching halt as people were advised to stay home to avoid getting sick. At the time, it seemed the housing market was poised for a downturn.

Instead, the opposite occurred. When real-estate transactions were allowed to resume, Americans flocked to buy homes . With jobs turning remote and schools becoming virtual, families sought more space in the suburbs.

Some city residents tired of their cramped apartments and decided to make a permanent move to more rural areas, while others merely opted to purchase second homes to escape to amid the stay-at-home orders.

With the sudden crush of people seeking to buy homes, prices skyrocketed. By November, home prices were rising at the fastest pace since the Great Recession, and price appreciation has yet to slow.

The demand for housing also triggered a building craze. Last year saw a 12% gain in the construction of single-family homes, Dietz said. The sudden increase in home-building activity has since caused a surge in the prices for lumber, driving up the prices of new homes even higher.

Fitch calculates that U.S. home prices in a quarter of the country’s metropolitan statistical areas are more than 10% overvalued. Home prices in Idaho (30%-34%) and Nevada (25%-29%) are “becoming more unsustainably inflated while Texas (15%-19%) has become frothier over the last year. “

What’s more, markets like Rhode Island and Washington (both 10%-14% overvalued) that have traditionally experienced more sustainable house-price increases “are now seeing similar disconnects between home price growth and economic fundamentals in place to support the rate of growth,” Fitch added.

Strong housing demand is pandemic-related

But experts are hesitant to make apples-to-apples comparisons between this housing market fueled in part by pandemic-related demand and low interest rates, and the one that preceded the Great Recession.

The circumstances contributing to today’s booming housing market are very different from what precipitated the last boom and bust cycle. In particular, lenders are being far more careful.

The housing boom that prompted the Great Recession stemmed from the rise of sub-prime lending. Banks and other mortgage lenders were originating riskier loans — often requiring little in the way of documentation from borrowers to prove they could afford their monthly mortgage payments.

Many loans also featured adjustable rates that ballooned after an introductory period. At the time, homeowners were also treating their homes like ATMs, refinancing into these risky loans to cash out the equity they built up.

By comparison, today’s lending practices are far more conservative. “Banks and mortgage lenders have been disciplined in extending credit, a very different approach than we saw in the previous housing boom,” said Danielle Hale, chief economist of Realtor.com. “In fact, banks have tightened underwriting requirements in the wake of lockdowns last year, so buyers today are more qualified than they’ve been in quite some time.”

As evidence of that, mortgage lenders are offering loans to borrowers with higher credit scores. Mortgage-credit availability plummeted in the immediate wake of the pandemic to the lowest levels in six years, and has only slightly recovered since, according to data from the Mortgage Bankers Association.

With banks being so careful, the demand seen the in the housing market today is much more organic. And the lifestyle changes brought about by the pandemic is not the only reason why demand has surged.

“Current demand is built on a significant growing demographic wave, as we have many millennials turning 30 — a key age for first-time home buying,” Hale said.

The common wisdom in real estate is that people are primarily motivated to buy a home not because of low interest rates or the investment potential, but because of life changes. Millennials are the largest generation — and they are getting married and having kids. As they experience these major milestones, owning a home is becoming a bigger priority.

Home shortages push prices higher

Florida, a housing market that was hit hard by the Great Recession, is also experiencing potential overheating, according to  Ken. H. Johnson , a real-estate economist and associate dean in FAU’s  College of Business .

Single-family homes, condominiums, townhomes and co-ops are more than 17% above their long-term fundamental house-price growth, but the extent of overpricing of these homes remains far below the 65% during the 2006 peak of overvaluations just before the Great Recession.

The big problem for home buyers right now is that there are not many properties to go around. As with the surge in demand, the rise in home prices isn’t artificial, unless you consider the coronavirus pandemic a temporary and/or artificial force fueling house prices.

“The heady home price appreciation during the pandemic certainly has some frothiness to it, but there is substance not far beneath that froth,” said Daren Blomquist, vice president of market economics at Auction.com, a real-estate platform that specializes in foreclosed and bank-owned properties.

Many home builders were burned by the last housing bust. Prior to it, some companies had engaged in speculative building practices, so when the market bottomed out they found themselves saddled with newly-constructed homes and few interested buyers.

As a result, home-building activity slowed considerably. Home builders have only ramped their operations back up in the last couple of years, experts say. In the meantime, many Americans were busy getting married and having kids — creating a huge gap between supply and demand.

A recent report from Freddie Mac estimated that the U.S. is 4 million homes short of being able to meet the demand of home buyers. That figure has grown by 50% since 2018.

Making matters worse, would-be home sellers have remained on the sidelines, constricting the availability of existing homes for sale. Some sellers are likely still nervous about the health risks associated with putting their home on the market amid a pandemic. Others are likely dismayed because they’re having just as hard a time finding a new home to live in, causing them to delay listing their home for sale.

Will COVID-19 spark a rise in foreclosures?

The housing market may be on solid ground when it comes to the demand for homes and the fast pace of home-price appreciation, but some risks to its health remain.

The biggest of these might be the ongoing forbearance situation in the mortgage market. As the economy went into a downward spiral at the start of the pandemic, lawmakers and financial regulators quickly instructed mortgage lenders and servicers to offer relief to borrowers who may have lost work or income.

In particular, Americans could request forbearance on their mortgage — allowing them to make reduced mortgage payments or skip them altogether — essentially without any questions asked. At the same time, a moratorium on foreclosures was enacted.

By late June, more than 4 million Americans were in forbearance on their mortgage. Millions of homeowners have since exited forbearance and successfully resumed making their monthly payments. However, the federal government has extended both the forbearance program and foreclosure moratorium on multiple occasions. As of mid-April, roughly 2.3 million homeowners were still skipping mortgage payments, according to an estimate from the Mortgage Bankers Association.

It’s not clear how many of those homeowners will be able to eventually restart paying off their mortgage, and the fate of the housing market could hinge on regulators’ success in preventing a wave of foreclosures.

Having all of these homes go into default at once “would tank the market,” said Joan Trice, CEO of the Collateral Risk Network, an organization of real-estate appraisers and risk managers.

“The forbearance rate is two times what it was in the last crisis,” Trice added. “It would be chaos and devastating to the market.”

The Consumer Financial Protection Bureau recently proposed extending the pause on foreclosures until 2022 and making it easier for borrowers to request changes to their home loans that would allow them to afford to stay in their homes. The consumer-watchdog agency also suggested it was going to scrutinize lenders’ and servicers’ practices to protect homeowners.

Plus, regulations introduced under President Obama make pursuing a foreclosure more onerous than it was during the last housing downturn.

“Combine all of this and the risk of large-scale foreclosures diminishes substantially,” said Edward Pinto, co-director of the American Enterprise Institute’s Center on Housing Markets and Finance.

To the extent that some homeowners may still go into default, it would not necessarily be widespread. Forbearance rates are higher among people who took out loans insured by the Federal Housing Administration, or FHA.

“The biggest risk lies with Federal Housing Administration (FHA)-backed loans originated since 2014,” Blomquist said. These loans were riskier, featuring higher debt-to-income ratios. Many of these borrowers relied on down-payment assistance to purchase their homes.

“Those FHA loans will be the most likely to fall into foreclosure post-pandemic, and markets with high concentrations of these loans could suffer as a result,” Blomquist said. The housing markets that have the highest risk based on FHA delinquency rates as of February include Atlanta, Houston Chicago and Dallas, according to research from the American Enterprise Institute.

The good news for homeowners in a bind right now is that, generally speaking, they have built up equity in their homes. And given the high demand for housing nationwide, housing experts say that most of these families should be able to sell their homes — even for a profit — and return to renting.

What happens if mortgage rates rise?

Based on past econometric modeling, J.P. Morgan Research found that “a reasonable rule of thumb” is a 100 basis-point decline in mortgage rates is associated with a 10% increase in home sales. But, experts caution, the opposite is also true.

The difficult forbearance situation isn’t the only threat to the housing market. Indeed, with home prices having risen as high as they have, many buyers are walking a fine line when it comes to being able to afford to purchase a property.

Rising mortgage rates threaten that equilibrium. “An extremely rapid and sharp rise in mortgage rates could cool demand so abruptly that it quickly shifts the market from boom to bust,” Blomquist said.

Most housing experts project that mortgage rates will only rise somewhat modestly this year. Interest rates have rebounded from the record lows set at the start of the year, but in recent works they settled around 3%.

Should rates resume their upward climb, home price growth is likely to slow in response, experts say. And that could give some buyers an opening, as affordability pushes others out of the market for the time being.

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