Remember 2008?

It represented the second-largest recession we’ve lived through, junior only to the Great Depression. Since the 2008 housing bubble and subsequent collapse, many Americans continue living with a sense of fear about the economy and the housing market specifically.

Many homeowners lost their properties in the wave of foreclosures that followed the lax lending practices endemic in the 2000s. Millions of borrowers took out loans larger than they could afford, many of them adjustable-rate mortgages. Once the rates adjusted, many were left with a payment they simply could not afford.

It might have remained a problem only for a handful of lenders and overleveraged borrowers. But investment banks had packaged these loans and sold them as mortgage-backed securities on stock exchanges across the globe. Once it became clear these investments were worth far less than advertised, global stock markets began crashing, and it created a perfect economic storm worldwide.

Fast forward to 2019. After nearly a decade of booming home values, some analysts worry that there may be another real estate bubble looming. Interest rates on the Treasury’s have been inverted for quite some time, a red flag often preceding recessions.

Couple that with sustained low interest rates, and many buyers find themselves increasingly hesitant fretting about a housing bubble in 2019.

 

What Is a Housing Bubble?

To better understand if there’s a real estate bubble we need to first understand what exactly a housing bubble is.

A housing bubble forms when home prices rise higher than the market’s fundamentals can justify. Fueled by speculation rather than inherent demand for housing, these artificially high property values prove unsustainable into the future.

Imagine a neighborhood that appreciates steadily for eight years in a row. Speculators notice, and begin offering a premium for those homes greater than their market value, increasing demand. In turn, homeowners begin selling at inflated prices because of the increased demand, but since there are limited homes, supply is stagnant, leading to increased home prices.

At a certain point, demand dries up because no buyers are willing to pay the inflated prices. The artificially high prices come crashing down, thus causing the bubble to “pop.” Certainly there are other factors that can contribute to a housing bubble, but this general outline offers an idea of what a housing bubble is.

 

Housing Bubble Timeline

Let’s go a step further and outline how a housing bubble works through a few simple phases, illustrating the high-level activities that may represent a housing bubble.

Phase 1 – Properties in Demand

It starts with a market where people actually want to live.

The demand for housing is real, and causes prices to rise faster than the surrounding areas. That begins to attract both speculative investors and homebuyers reaching beyond their comfortable price range.

Phase 2 – Expectations of Appreciation

In the second phase, excitement and high expectations begins spilling into the decision-making process. Buyers assume that prices will continue appreciating at the current faster-than-average rate.

That assumption of future growth, rather than market fundamentals like local incomes, fuels higher pricing. See the circular logic?

“I’ll pay more this property because I know future buyers will soon pay even more.”

 That sense of buying frenzy spurs developers to build ever more supply as well. But it takes time to build homes and apartment buildings, often measured in years, which means developers fall behind the market fundamentals.

Here’s what the housing market cycle looks like visually:

Phase 3 – Inflated Purchase Price

When demand starts becoming fueled by the expectation of price increases, rather than demand by local residents to live in the neighborhood, home prices start inflating artificially. Some buyers reach beyond their comfortable budget, aided by low-down-payment loan programs and loose income requirements.

And it works – for a little while. It creates a self-fulfilling prophecy, a feedback loop of higher prices fueling more demand with the expectation of further appreciation.

It doesn’t last.

Phase 4 – The Bubble Bursts

Once homebuyers and speculators realize it costs more to live in the neighborhood or city than it’s actually worth, demand begins to dry up. Prices stagnate briefly, then when sellers can’t find a buyer, they lower their prices. It happens slowly at first, but once it becomes clear that there’s no demand at current pricing, demand falls even further.

Some homeowners end up underwater on their mortgages as prices fall. If they start defaulting on their loans, a wave of lower-cost foreclosures hit the market, driving prices even lower.

Investors don’t want to touch the area, and homeowners won’t either until prices drop enough for them to feel like they’re getting a “deal.” Which eventually happens: prices go so low that the neighborhood becomes attractive-priced again.

And the cycle starts anew.

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Is the US in a Housing Bubble in 2019?

The odds of a nationwide Great Recession-level housing bubble are certainly less likely than they were in 2006. That resulted from a perfect storm of loose lending practices and poorly-regulated investment bankers creating derivatives that no one else understood.

To explore if there is a housing bubble in 2019, you need to both dissect specific housing markets and identify larger trends. All real estate is inherently local, after all. Discussing the “nationwide real estate market” is like discussing the “nationwide weather” – it isn’t very useful or meaningful except as an insight into trends affecting many markets simultaneously.

It’s natural for homes to increase in value a few percentages each year. But when prices increase double digits for a length of time, it’s a cause for deeper research.

In July, Forbes released a report the state of the US housing market in 2019. As you would suspect, housing prices have begun to slow, partially because they’ve been rising so much faster than incomes.

“The two have to snap back together eventually.” – Skylar Olsen, Director of Economic Research at Zillow.

You can view both home prices (as measured by the Case-Shiller Home Price Index of the 20 largest cities in the US) and incomes compared below, showing home prices outpacing incomes, but not to a worrying extent. At least not yet.

Courtesy of Knowledge Leaders Capital

 

That conclusion was reinforced in Fall 2019 by a study by UBS evaluating the largest cities in the US. The study found that even the most expensive cities in the country have not crossed into bubble territory, although some did register as “overvalued.” Here’s the map:

 

Case Study – Housing Prices in Seattle and San Francisco 2019

While the nationwide average of housing markets look reasonably healthy and stable, but there are a few markets that have seen a more drastic pullback in prices. In Seattle, prices had continued to accelerate greater than anywhere in the country for two years. Then, from April 2018 to April 2019, home price growth contracted 13.8%.

Courtesy of The Seattle Times

 

Similar contraction occurred in San Francisco, where growth contracted 10.9% to an annual gain of 1.8%.

As outlined in the timeline of a housing bubble, these moves can be traced to the market appreciating too quickly. Localized housing bubbles appear when local buyers believe real estate will continue skyrocketing in value. Even when prices over-inflate to unsustainable premiums.

While home prices appear overvalued, these markets may not be in a true bubble. Home values look to be easing organically without crashing, even as incomes continue rising in these cities.

Yet a true real estate bubble indicates a much larger and catastrophic crash in values. Even in these overvalued markets, a 10% or higher crash in values doesn’t seem to be looming, although they may see a noticeable price correction over the next few years.

 

So, a Housing Bubble in 2019?

While a handful of local markets appear overvalued, few analysts believe the US faces a housing bubble in 2019.

For example, the economy here in the U.S. continues to expand for a record 121 consecutive month. Consumers continue to have confidence in the market as the University of Michigan Consumer Sentiment index remains at current highs.

“During the last nine years, the expansion has created more than 20 million jobs, raised family incomes and rebuilt consumer confidence” – Frank Nothaft, Chief Economist at CoreLogic

A broader economic recession could slow or reverse home price growth, even in the absence of a real estate bubble. Often economists look at luxury markets such as the RV industry as early predictors of recessions. Luxury items historically make up the first markets to decline before a nationwide recession occurs. In 2018 and 2019, RV sales have seen 12 straight months of year-over-year declines. While this may not seem like much, it’s the first decrease in the last several years.

Recession fears aside, most housing markets across the US appear strong and healthy. Lending practices remain tighter than in 2006, despite loosening over the last five years. It’s difficult to find convincing evidence of a real estate bubble in most markets.

To find undervalued markets, see our research and lists of the best cities for real estate investing in 2019!

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Survival Guide for Investing in a Housing Bubble

While there may not be a real estate bubble imminent in 2019, it’s important to understand what investing through a bubble should look like.

 

Buy Discounted Properties, Rather than Trying to Time the Market

First, don’t attempt to time the market. Market timing usually comes down to luck, and most of the time you’ll miss out on large market moves in pursuit of short-term gains.

If you wait for the next dip to buy, it could be years away. By that time, even the low point in the dip could mean higher prices than today’s values. Alternatively, if you rush to jump into a rapidly appreciating market, you risk buying in the midst of housing bubble mania.

Instead, dispassionately look for an investment that you can buy at a discount from market value. See our guide to finding deals on real estate even in a hot market for specific tactics, and look for motivated sellers. You can use an online tool like Propstream to find them instantly (full Propstream review here), or stick with classic strategies like driving for dollars.

For those of you who invest in stocks, think of it like value investing. Even in 2006 when home prices peaked, there were still plenty of undervalued markets and individual homes. From peak to trough of the housing crisis, the state of North Dakota averaged only a 2% decline in property value.

 

Avoid Speculation

Look for markets with steady but reasonable gains, rather than sharp spikes in home values. Sudden leaps in pricing often mean a divergence between incomes and home values.

Your real estate investments make up one part of a larger portfolio. Just like selecting stocks, you don’t want to speculate a large part of your portfolio.

 

Invest for Cash Flow

Most of all, to survive a housing bubble you’ll want to identify properties with strong rental cash flow. Rents tend to remain stable or even increase through any economic cycle. Even during the Great Recession and housing bubble of 2008, rents did not decline – they simply grew less quickly than they did previously. In a recession and real estate bubble, some homeowners end up becoming renters, which fuels demand for rental housing even as buyer demand dips.

Don’t believe me? Here are average US rents from 2005-2017 (blue is median, green is mean rents):

The moral of the story: aim to buy properties that become real estate cash flow machines! Properties you can buy below-market value, but for the right reasons. It can be a real estate market that’s not seen by investors, small communities or a location that ignores typical recession factors.

Fortunately, you can calculate a property’s cash flow before buying. Use our free rental property calculator to run the numbers on any property, and never buy a bad deal again.

For more tips for investing in any phase of the housing cycle, see our tips for making money during housing market corrections.

 

Final Thoughts

Does the U.S. face a real estate bubble in 2019? I believe the odds are low, at least as a nationwide average. The economy continues to expand, albeit slower than over the last decade, and as interest rates lower, the cost of borrowing decreases.

Most of all, do your due diligence when evaluating potential deals. Make sure you have a firm understanding of the local market. When you know the local market and the prospective property well, you can predict your cash flow and returns accurately.

And in doing so, protect yourself from losses in the next recession or housing bubble.

 

Do you think your home city is in a housing bubble in 2019? Why or why not? Share your thoughts below!

 

 

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