America's Real Estate Is Booming, But Is It A Bubble?

by: D. H. Taylor

Median real estate prices are up 160% since 1990, whereas incomes are up 90%.

Total number of second homes are declining.

Price increases are ultimately unsustainable and the Fed will be shrinking their balance sheet, shrinking real estate investments.

The existing homes sales was released Friday morning. The number surged above expectations. The housing market is the strongest game in America's economy. The release made me want to take a more-than cursory look at what was going on in housing. The angle I am taking is price increases as well as income increases. There should be some kind of realistic correlation. There is not. The stimulus the Federal Reserve pumped into the system while the economy was near death is working its way into assets. Asset prices are surging. This will only get far, far worse before a correction happens. I am bullish on real estate, but I am also looking for the Federal Reserve to be forced into doing something about it in a punitive manner. This may not happen for some time, but that time is likely coming.

The banks are starting to lend money out for real estate purchases. This trend has been growing. It is not at the high that it saw in the real estate bubble. But, the growth is impressive. For visual perspective, here is the chart for existing homes sales on a 1-year basis and then on a 10-year basis:

After the financial collapse, the world saw a slowdown in 2013 into 2014. Aside from that, the trend has been upward and sustainable. These charts by themselves do not make me fearful in any way. That is because a chart is fundamentally useless without comparing it to some kind of marker.

So, let's do that to put everything into perspective.

Here are charts from the St. Louis Federal Reserve Economic Data (FRED) that show the median price increase for houses in the United States as well as the chart for the median income in the United States, respectively:

Both of these charts are from 1990 onward. Both of these charts are not inflation adjusted. The first chart shows 1990's median home price of $120k with an ending level of $320k, or, roughly a $200k increase in a 27-year period of time. That equates to an increase of 166%. The second chart, median income, had a 1990 level of $30k with a current level of $57k, or an increase of $27k. That translates into a 90% increase for that same period of time.

If the cost of your housing increases a certain percentage but the level of your income does not keep up with that same pace of growth, is that sustainable? That depends on how much you like to eat ramen noodles. The plain fact is something has to give until there is nothing left to give. Consumption of other things like vacations and expensive food are usually the first things to go.

It used to be that the level considered the most you would want to spend on your housing was 30% of your income. Here is a chart, again from the St. Louis Federal Reserve, that shows a graph of the United States and the counties that are "burdened" by housing. This chart, from GEOFRED, shows how burdened a county is by the level of income being contributed to housing. Anything above 30% gets colored, and the darker the color, the higher the burden. Some of these 'burdens' go as high as 56% of income being contributed to housing (if you go to the GEOFRED link, the chart is interactive and you can check your individual county).

The plain truth is that the pace of prices for housing are far outpacing the growth of incomes. However, I do not see this as a bubble. A bubble would be indicated by massive amounts of speculation. That does not appear to be the case. In fact, the number of second homes has been continually declining:

Affordable housing is continually out of reach of Americans. This pace cannot go on in perpetuity. But, it is not a bubble. It is just that the cost of housing is outpacing incomes.

I believe the Federal Reserve will be addressing its balance sheet by shrinking it to a more reasonable size. I also believe that this will ultimately have an effect on the price of housing. This will take time. But, before that happens, the pace of purchases of real estate and the prices thereof look set to continue to increase. This is good news if you are involved in real estate holdings such as REITs and ETFs, or own property yourself. It is bad news if you have not made that plunge yet.

At some point, however, when the Fed starts to shrink their enormous balance sheet, that may be a very good time to exit the most liquid real estate holdings.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.