Are we in another real estate bubble? People ask me some really difficult questions, and this is one requires a lengthy answer.
The answer is: Not Yet, I think. – It depends who you ask and it depends on what you consider over-inflated housing prices…
There are a lot of people questioning this right now with good reason. First of all, we all experienced a very painful real estate market correction so the pain is fresh in our minds. Also, many of us all understand that something isn’t quite right about this recovery but can’t quite place our fingers on exactly what it is.
A healthy real estate market is a balanced supply and demand ratio driven by economic growth and job growth. This recovery seems to have bypassed that and gone straight from ridiculous levels of over-supply to extreme demand overnight. Economic and and job growth seem to be no where on the horizon.
While it may seem magical, there were forces at work behind the scenes.
The Fed had been ‘tinkering’ with the markets since 2008 with different attempts to influence the stock market and interest rates. The super low interest rates we have been seeing is a result of those actions.
Below is a chart I quickly put together, it isn’t exactly pretty but it shows the Twin Cities Median Sales Price of homes over the last 10 years and the average 30 year fixed rate mortgages with indications on Fed Action dates.
The Fed action dates I pulled from Calculated Risk blog.
• November 25, 2008: Press Release: $100 Billion GSE direct obligations, $500 billion in MBS
• December 16, 2008 FOMC Statement: Evaluating benefits of purchasing longer-term Treasury Securities
• January 28, 2009: FOMC Statement: FOMC Stands Ready to expand program.
• March 18, 2009: FOMC Statement: Expand MBS program to $1.25 trillion, buy up to $300 billion of longer-term Treasury securities
• March 31, 2010: QE1 purchases were completed at the end of Q1 2010.
• August 27, 2010: Fed Chairman Ben Bernanke hints at QE2: Analysis: Bernanke paves the way for QE2
• November 3, 2010: FOMC Statement: $600 Billion QE2 announced.
• June 30, 2011: QE2 purchases were completed at the end of Q2 2011.
• September 21, 2011: “Operation Twist” announced. “The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less.”
• June 20, 2012: “Operation Twist” extended. “The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities.”
(check his chart out as he shows these dates and the S&P 500)
Quantitative Easing and Operation Twist seem to have been the catalysts that spurred on the low interest rates which is driving the sellers market. While this has has spurred life into a fledgling real estate market, the longer term impacts are yet to be seen.
So what happens when interest rates go back up? Will a $300,000 home still be worth $300,00, or will the price have to drop to accommodate for the change in mortgage payments? The answer will depend on the job growth…
How will the markets correct when the Fed stops injecting money into it? Will it drive the bonds to record high rates which will bring mortgage rates sky high or will it be a gradual transition?
While there are some pretty big unknowns in my mind about this resurgence in the housing market, I do believe it is still a good time to purchase real estate taking advantage of these low interest rates. I personally like the asset based investment, especially since I need to live somewhere anyhow – why rent? I also like it because historically home values have paced inflation, and we may see inflation from all this Fed stimulus!
My recommendations when buying now are:
- Make sure Rents support the value of the home you are buying. (this is ultimately the true value of a property.)
- Be conservative, don’t take on more debt than you can really afford.
If you are concerned about these 2 fundamentals, then maybe you might listen to Nobel Prize winning economist and creator of the Case Shiller Index, Robert Shiller:
Nobel prize winner warns of ‘bubbly’ home prices
….Bubbles are created when investors fail to recognize when rising asset prices become detached from underlying fundamentals….
Shiller and other economists warn that prices in some markets have risen too far, too fast due to the Fed’s ultra-easy monetary policy.