I'm frequently asked if home prices are a bubble now. There's certainly reason to wonder. In fact, I get that question a lot. To lay the groundwork, I recently explained what a speculative bubble is.
The key is that prices are being bid up substantially by people expecting a short-run gain. Price can rise because of fundamentals, such as greater demand or limited supply. Such price increases are not a bubble. However, fundamental changes can trigger growth, which sometimes leads people to believe the growth will continue, in turn leading to speculative buying.
Look at these home price increases, each calculated over the past 12 months:
- Case-Shiller 20-city index: +12.1%
- FHFA's House Price Index: +7.3 percent
- CoreLogic: +11.9%
- Trulia Asking Prices: +11%
- New single family home median: +7.4%
- National Association of Realtors existing homes: +12.2%
So do all of these statistics point to a bubble?
Is there good reason for home prices to rise? Sure there is. Look at the underlying demand growth. Population is growing, though slower than in the past. The number of people living in a household has dropped from its peak in 2008. That means we need slightly more houses for a given number of people. Mobile home sales have dropped so sharply that they hardly play a role in national statistics anymore. We need about 1.2 million new housing units per year, on average. Maybe it's only 1.1 million, but it's certainly something in that neighborhood. Housing completions last year totaled 650,000 units, far short of our average need.
We managed with low levels of new construction because we entered this era with a large overhang of houses built in the boom. We have now brought that overhang way down. The vacancy rate of non-rental housing peaked at nearly three percent but has dropped to just 1.9 percent. The long-run average is about 1.5, so we're getting close to normal. For rentals, vacancy is down to 8.2 percent from a high of 11 percent. Average is about seven percent, but there was some drift up to eight percent even in the 1990s.
In a nutshell, we need to be building more houses than we have been. That's a fundamental justification for rising home prices. For 2013 we have construction data through June showing we're on pace to build about 900,000 housing units of all kinds.
Also on the plus side of the ledger is low mortgage rates, which help people move from rentals to owned housing. The recent rise in rates probably motivated some fence-sitters to get moving.
Finally, let's talk anecdotes. When I talk to people who are shopping for houses, I don't hear the flipping talk that I heard in 2005 and 2006. People are buying to live in the house. They may think it works out economically better than renting, but they are not anticipating a quick buck. The ones buying for investment are focusing on rental income rather than resale value.
Does the future hold rising home prices? Not so fast. Remember that prices can fall for fundamental reasons. We don't have to label this episode a bubble to see prices decline. There are a couple of reasons for concern. First, there are plenty of empty houses, frequently bank-owned. These houses will eventually find their way on to the market. Sure, the bankers are doing a really lousy job of managing this real estates, but eventually they'll put the empty houses on the market. That will be a downward force on home prices. If home prices appreciate much more, then institutional investors who have bought single family homes for the rental market will take their profits and move elsewhere. That's another downward force. I'm not too worried about rising mortgage rates' impact on home prices, as I wrote in an earlier article. However, a generally weaker economy would be harmful to home prices by lowering employment and wage gains.
A good long-run forecast of housing prices is about three percent growth, on average. Any given year can see falling prices as well as rising prices.
The current price increases are not a bubble. One could possibly develop, but I doubt that will happen with current attitudes. Perhaps again in 20 years a housing bubble will develop, but too many people have been burnt recently.
The absence of a bubble does not guarantee stable or rising prices, however. If one thinks of a house as a place to live and buys what the family can afford, things will probably work out well over the lifetime of the family's ownership.