No Housing Bubble
Elliot Eisenberg, Ph.D.,
February 3, 2016
House prices are once again regularly in the news and have been rising for 43 straight months. In cities such as Boston, Denver and San Francisco, prices today are higher than they were during the peak of the housing boom. In other cities, while prices have not regained the ground they lost during the housing bust, they are rising smartly and are not far off the peak prices of last decade. That said, a housing bubble does not appear to be forming, and even if one is on the horizon, it certainly is not being credit-fueled, and thus is far less dangerous than what we recently experienced.
While in a few cities home prices are at or above the highs of the housing boom, on average, home prices are still well below their previous peaks. Depending upon the house price index used, sales prices are currently 5% to 10% below their 2006 peaks, and at levels first observed in early to middle 2005, six to 12 months before they peaked. Moreover, after adjusting for inflation, house prices are about 20% off their all-time highs. At the current rate of house price appreciation, it will take another four years for inflation-adjusted house prices to fully regain their 2006 levels. Despite the rhetoric, house prices are not nearly as high as they are being made out to be.
In addition, back in 2006, housing affordability was dismal. At that time, a family earning the median income barely had enough income to qualify for a conventional conforming mortgage for the US median-priced home. Today, that same household has almost 170% of the income needed to qualify for the median-priced US home. This is because house prices are lower and interest rates are substantially lower than they were almost a decade ago.
Two esoteric but very important financial measures reinforce the conclusions above. Both the price-to-rent ratio and the mortgage debt-to-GDP ratio have fallen precipitously. The price-to-rent ratio is similar to the price-to-earnings ratio for equities, and the higher it is, the more homebuyers are willing to pay up front to receive a flow of future rent payments. At the peak, the price-to-rent ratio was easily 50% above what it averaged between 1983 and 2000. Today it is about 10% above the 1983 to 2000 average level, and almost 30% below the 2006 peak.
The ratio of all debt (most of which is mortgage debt) to GDP has fallen from 100% of GDP to 80% of GDP. Moreover, despite the recent run-up in house prices, the mortgage debt-to-GDP ratio has continued to decline. This reflects a return to prudent lending standards and reduced household leverage. Collectively the improvement in these ratios strongly suggest that we are not in the midst of a credit-induced lending bubble. In addition, housing starts remain about half of what they were during the prior peak. This means that our economy is far less dependent on residential construction activity than it was then.
To review, while house prices are up, inflation-adjusted prices are still years away from their peak levels. In addition, affordability remains high and both the price-to-rent and mortgage debt-to-GDP ratios are much lower than they were. These four indicators collectively indicate that there is probably no housing bubble, and even if there is one, it is not the result of increased household leverage, which is what primarily precipitated the last housing bust.