For generations, it was always a good bet to invest in a place Americans call home. Housing had almost always increased in value, and you received a multiple of whatever you invested into it in your total return.
Until 2008 that is.
That’s when home prices tanked and our economy entered a recession, leaving people like you and me holding the proverbial paper bag when it comes to overpriced and overleveraged mortgages.
Since then, the root cause of the housing bubble has remained in place — easy-money policies by the Federal Reserve to fuel lending. It has led to another housing bubble.
One that is set to burst sooner than most are anticipating.
Since 2009, the Fed has pinned interest rates near zero in an attempt to prop up our aging, lackluster economy.
With a sub-2% GDP growth rate, it’s hard to believe that this has been a success.
But the easy-money policies have propped up aspects of the market, just not in the pockets of the everyday American. Instead, it has bloated the pockets of Wall Street and investors.
Had someone told you in 2006, 2007 or even most of 2008 to sell your home, you likely would have ignored them. Not many people on Main Street noticed the lending practices going on behind the scenes and understood the extent of the bubble that was in place.
But hindsight is always 20/20.
The problem now is spotting similar bubbles going forward.
I’ll be the first to say that timing the week, month or even year that a bubble will pop is extremely difficult. But that doesn’t mean you can’t notice when that day is near, and for housing it may be just around the corner.
The Truth About the Housing Bubble
Before I go into the details, take a look at this chart:
This chart compares existing home sales (in red) to the median sales price of those homes (in blue). As you can see, there is a substantial divergence as we approach 2015. Prices have climbed about 50% since 2000 and rebounded strongly from the bottom in 2010 to 2011. But existing home sales — the amount of homes actually sold — have lagged and are up just 5% since 2000.
Median prices have topped their bubbled peaks set in 2005, but this time, the amount of homes sold is 30% less.
That means we are seeing prices set new highs as fewer buyers are in the market.
The rationale is that housing currently has a tight supply, meaning there aren’t enough homes to meet the amount of potential buyers. That may be the case to some extent. But right now, homes that are either in foreclosure, bank-owned or completely vacant are near all-time highs.
Clearly there is more going on here than just a lack of supply. The reality is that many buyers are investors, buying properties and sitting on them. This crimps supply, which helps raise prices.
Back in 2008, you could have heard the same story. The goal was to flip houses, or own a few of them to rent out. We are seeing these actions roaring back today.
And if supply was so tight, buyers would simply build new homes, but those numbers are no better than the existing home sales.
Again, a big discrepancy from new homes sold versus the price these homes are fetching — and this is supply that is practically infinite as we can always build a new home.
Something’s got to give, and it’s going to happen soon.
I see one of two scenarios at play. Which one do you think will ring true?
- Homebuyers continue to fork over more dollars to buy properties while we sit with stagnant wage growth, stagnant economic growth and low-wage jobs being about all that’s created.
- We are on the edge of a bubble larger than the one we experienced less than a decade ago as housing prices race back down to where it is affordable and sees demand from new buyers.
The Federal Reserve is held accountable for this fiasco. If it goes forward with a rate increase in the near future, it will be us who pay the price of another bubble.
There’s only one action to take if you ask me — lower your exposure to the industry.
In stocks, that’s homebuilders and mortgage originators. Avoid them at all costs. In your personal investments, that’s being prepared for another real estate shock.
These prices are unsustainable and due for a correction.
Once that happens, opportunity awaits you to pick up houses and housing-related stocks on the cheap.
Editor, Pure Income