2015 Housing Market is Already in a Bubble Larger Than 2006

Housing today: A 'bubble larger than 2006'

October 6, 2015

CNBC - Home prices are gaining steam again, fueled by tight supply amid growing demand.

Nationally, home prices were nearly 7 percent higher in August compared to a year ago, according to a new report from CoreLogic. That is a bigger annual gain than we saw during the spring market in May and June. Other monthly reports have shown the same phenomenon.

"It is clear that house price growth has picked up recently," noted analysts at Capital Economics, comparing August's annual gain to a 4.8 percent rise in February. "Indeed, with the months' supply of homes close to a 10-year low, if anything, both CoreLogic and Case-Shiller are reporting slower growth than might be expected."

While home prices nationally have not yet returned to their peak of the last housing boom, some local markets have surpassed it. Now, some claim the housing market is in a bubble far worse than the devastating one in 2006. The argument: Housing is far less affordable today than it was back then, and the home price gains are driven not by healthy, end-user demand but by a lack of construction, artificially low interest rates, and institutional and foreign all-cash buyers.

"In the days of 'anything goes,' ninja financing caused housing prices to lurch higher, which forced people to rush in and buy, which in turn pushed prices higher, thus increasing volume more, and so on. But when it comes to the new-era, end-user buyer, that can't happen any longer, as buyers actually have to fundamentally 'qualify' for the mortgage for which they apply," wrote housing analyst Mark Hanson in a note to clients.

Hanson, often criticized for being a housing bear, points to the institutional and foreign buyers who have flooded the market since 2012, buying up distressed and lower-priced homes, as well as some new construction, all with cash. He calls it an exact replay of the last housing boom, "when unorthodox demand with unorthodox capital would pay any price it took to hit the bid."

California-based real estate analyst John Burns, of John Burns Real Estate Consulting, called Hanson's premise "ridiculous." He said you cannot compare affordability today to the heady days of the housing boom when anyone could get a loan with no money down and artificial — now illegal — teaser rates.

"That was an awkward, unusual period that is not coming back," said Burns, who claims 90 percent of the nation's local markets are "affordable" when home prices are weighed against income.

He also pointed to low down payment FHA loans. "All you have to do is show up with that down payment and prove your income," he said.

That said, rising mortgage rates are a concern, Burns said, admitting home prices have been inflated in part by artificially low rates.

"We will have a problem if rates go up," he added.

First-time homebuyers, who are having a very hard time getting back into the housing market, say they are often outbid by all-cash buyers. In markets that were particularly hard-hit by the housing crash, like Phoenix, Las Vegas and Atlanta, they simply cannot compete with investors.

Investors put a floor on prices during the recession, but they also drove them far higher than expected. Institutional investors may make up a small percentage of overall homes purchased since 2012, but they make up a huge share of buyers of distressed, low-priced properties. Also, the impact of individual investors and foreign buyers is largely underplayed. They, too, come bearing cash.

"In short, end-users today are being handed a red-hot potato market already in a bubble larger than 2006," noted Hanson.

The argument is founded in basic mortgage math. The majority of regular, owner-occupant homebuyers today need to get a mortgage to finance the purchase. Unlike during the last housing boom, when money was basically free, they have to have a down payment, good credit and enough income to qualify for the debt.

Even with interest rates today considerably lower than they were during the housing boom, housing today is far more expensive. Buyers can't just pay interest on the loan, they have to pay principal as well. They have to put at least 3 percent down, and if they are using that low a down payment, they have to pay mortgage insurance. The income needed to qualify for a loan today is also far higher than it was then.

Wall Street appears to believe that housing is going gangbusters right now, because prices are jumping and demand is returning. Home construction, however, while improving from the depths of a pit, is still dramatically lower than it was not just during the housing boom but even during more normal housing cycles. That is the disconnect.

"Four years in, I would think the housing market would be further along. I think it means we're going to have a longer, slower recovery ," said Doug Yearley, CEO of luxury homebuilder Toll Brothers (TOL),on CNBC's " Squawk Box " last week.

In the same interview, Yearly claimed housing is more affordable today than it was during the last housing boom. That may be because prices have not returned to those peaks.

But as with everything in real estate, affordability often has to do with location. For young adults in big cities and hot real estate markets, homebuying can be a challenge.

A caller into C-SPAN's "Washington Journal" on Tuesday morning identified herself as Rachael, a married, working millennial who pays $1,600 a month to rent her one-bedroom apartment in Northern Virginia, but, "would love to buy a condo." She said she cannot afford the sky-high prices.

"It gets really expensive for a first-time homebuyer," she said.