Is the market going to crash?
Those jostled by the news that the housing market could crash have every reason to be worried. And why is that so? Because the last time the housing market soared like this—it sparked a great recession that left many in financial ruins.
The Real Estate Market Crash is Coming Sooner Than You Think
Typically, a rapid increase in home prices, a rising housing demand, and home flippers precede a real estate crash.Until recently, real estate was experiencing record low-interest rates, making housing affordable. However, that has caused skyrocketing house prices. It is crystal clear that demand is outpacing supply. What’s next? Could mobile and modular homes be the fix?
The sale of mobile homes might just be a potential fix to the American housing shortage, because they take a shorter time to build than site-built homes.
Google reported that “When is the housing market going to crash?” has been a hot topic since March 2021. Many are anticipating that history will repeat itself, with a repeat of the 2008 housing market crash.
Speculation is rampant about how and when the real estate market could crash—but first, what can we learn from the 2008 housing market crash? Here are some interesting facts about the events preceding that crash.
In 2022, despite higher mortgage rates, the real estate market is still hot. Monkey Business Images/Shutterstock
Causes of the Housing Market Crash in 2008
The housing market crash 14 years ago ignited a worldwide recession. The sole reasons for the crash and financial crisis boiled down to predatory private mortgage lending and unregulated markets. Here’s what preceded the great recession of 2008:Housing Prices and Foreclosures
Prior to the market crash in 2008, housing prices shot through the roof, with speculative buyers flooding the market, leading to demand exceeding supply.In the early-to-mid 2000s, mortgage lenders revised their lending standards, which opened a window to borrowers with poor credit, allowing them to get access to loans and secure home purchases. The easing of lending standards created an opening for many to access mortgages.
The Rise of Mortgage-Backed Securities (MBS) Was Hugely Misunderstood by Many Investors
The high demand in the housing market propelled an increase in risky mortgage lending practices. At the same time, the Federal Reserve Bank raised the interest rate to 5.6 percent by June 2006.What about Adjustable Rate Mortgages?
While many of those with conventional loans weren’t affected, those with adjustable rate mortgages (ARMs) were the casualties. Plunged into unforeseeable debt, many defaulted, leading to a huge rise in foreclosures in the housing market.In 2008, the number of foreclosures spiked to a record high of 81 percent, according to a CNN report. A total of 861,664 families lost their homes to foreclosure that year. This led to more inventory availability, and a subsequent crash.
Banks’ Risky Behavior
The rise of Mortgage-Backed Securities (MBS) led to financial institutions extending their mortgage lending. Many banks seized the opportunity for a lucrative long-term benefit. All was well until the bubble burst, leaving a huge collateral of subprime mortgages.On the other hand, banks stopped lending to each other in fear of being trapped with subprime mortgages. Even after the Federal Reserve cut interest rates, it wasn’t enough to stop the bleeding economy (the panic).
The Stock Market Crash
The stock market crash led to many losing their wealth. This was caused by the increasing number of closures and housing busts. In fact, the major financial markets lost more than 30 percent of their value by September 2008, when the Dow Jones Industrial Average fell 777.68 points, which exceeded its 684.81 loss on Sept. 17, 2001, the first trading after the September 11 attack.According to a report by NCBI, between 2007 and 2011, one fourth of American families lost at least 75 percent of their wealth, and more than half of all families lost at least 25 percent of their wealth.
Are You Following Current Events?
Now, back to the present, can you see the similarities? It is clear that housing markets are in a bubble. In this article, we’ll reveal why we think the real estate market crash is coming soon.
PhotoMIX Company/Pexels
Real Estate Market Crash Coming Soon
Analysts have made their point: the federal government has had its say, different perspectives have been put forward in a bid to break down the events of the current housing market.Statistics and History
Statistics and history agree. The only question remains, will the housing market crash this year?Whether you love statistics or not, we’ll try to help you see why the market could crash sooner rather than later. A market crash doesn’t happen in a split second; it builds over time.
Watch Economic Factors
Economic factors at play, the forces of demand and supply, drive a free market like real estate. Frank Nothaft, a chief economist at CoreLogic, said a year ago, “We’ve got an acute shortage of supply on the market for sale at the same time that record-low mortgage rates are driving the appetite to buy by millennials and Gen-Xers.”New York City Prices Among Others
For instance, Bloomberg reported New York City home prices are rising fast. New Yorkers who may still be working from home a year into the pandemic are fanning out across the boroughs in search of housing that is spacious and cheaper.Whenever one side outplays the other, a disequilibrium is created, an imbalance in the market. For example, basic economics dictates that interest rates and housing prices have an inverse relationship. As such, when interest rates are low, house prices go up. Why is that?
It’s simple: when the rate is low, housing becomes cheaper or affordable to acquire; this, in turn, creates a high demand for housing since it’s affordable at the time.
The Investors
Investors or homeowners, on the other hand, will try to take advantage of the rising demand by increasing prices. As prices rise it will cut off some people who will suddenly be unable to purchase homes. Now, demand is brought down by price growth, thus justifying the inverse relationship with the interest rates.
Many people have mortgages. Almost nobody wants to see the real estate market crash. Shutterstock
The Housing Bubbles Burst
You’ve heard the term housing bubble. Do you know what it means? What causes it? And if it burst, what factors are the last straw that breaks the camel’s back?Day by Day, It’s Harder to Deny the Fact the US Housing Market Is Overheating
Across the country, the housing market was 3.8 million single-family homes short of what was needed to meet the country’s demand, according to an analysis by mortgage-finance company Freddie Mac in May 2021.Home Price Surge also Suggests an Asset Bubble
COVID-19 hasn’t slowed home prices at all. Instead, they’ve skyrocketed. In September 2020, they were a record $226,800, according to the Case-Shiller Home Price Index.According to the National Association of Realtors, the sales rate reached 5.86 million homes in July 2020, and by October 2020, it had blossomed to 6.86 million, beating its pre-pandemic peak. Many people were taking advantage of the low rates to buy either residential homes or income-based apartments, which seem affordable.
COVID-19, on the Other Hand, Has Created a Slow Economic Activity Resulting in a High Unemployment Rate
According to the Labor Department, the U.S. lost 140,000 jobs in December 2020 alone. A rising number of job losses means few people will afford to buy houses, while those with mortgages will likely default and increase the number of foreclosures.On the other hand, job losses have forced many people to seek Plan B, going for mobile homes that are exceptionally affordable during this time.
Pexels/Pixabay
What Is a Housing Bubble?
A housing bubble happens when the market price of residential real estate sharply rises. Usually, this happens when the demand for houses exceeds the supply in the market. The rising demand triggers speculators to enter the market to profit from future expectations.The Presence of Speculators in the Market Further Pushes the Demand Higher
So, yes, speculators entered the market, and in response, home prices shot up, stretching the housing market bubble even further. Now it reaches a time when the home prices are no longer affordable to buyers. The unsustainability caused by the rising prices leads to homes being overvalued. In other words, price inflation.When the Prices Become Unsustainable and Buyers Pull Out, Demand Falls
Prices are unsustainable—but interestingly, the supply increases. Simple economics at play here. Now that the demand has fallen, what happens next? Prices come crashing and the bubble bursts.When questioned about the possibility of a bubble, Ali Wolf, chief economist at housing research firm Zonda, said in 2021, “Homebuyers today are purchasing for many healthy reasons: Low-interest rates, more flexibility to work from home and increased saving are all rational reasons for buying a house. The frenzy fueled by these factors, combined with fear of missing out, has the potential to create a bubble though.”
What Causes a Housing Bubble?
Real estate is a free market: the law of demand and supply applies unconditionally. When the demand for housing increases, subsequently, home prices go up. Usually, the supply of homes takes time to match the rising population of young Millennials who are seeking first-time homes. It always plays a catch-up game.Building a house takes time, causing a deficit in supply and thus demand exceeding it. Either way, prices will eventually increase the moment demand outpaces supply. To sum it up, the asset bubble is down to a combination of factors. One such factor is a healthy economy, where disposable income grows, and people feel secure in their jobs and confident about searching for a house, increasing the demand.
The Mortgage Rates Also Play a Huge Role in the Asset Bubble
Low mortgage rates drive up demand. Why? Mortgages become more affordable and buying a house is a lot easier, causing many borrowers to run for cheap loans.The rising number of subprime borrowers also causes the demand to further rise in the real market. The market had experienced record low mortgage rates in 2021, driving housing demand up.
The other factor is the speculators who are always in waiting mode to take advantage of an opportunity whenever it presents itself. Further rise in demand leads to overvaluation of houses which asserts the asset bubble growth.
Forces that Burst the Bubble
When push comes to shove, and prices aren’t reflective of anything close to fundamentals, the bubble bursts. At this point, the demand decreases while supply increases resulting in a sharp fall in home prices.Home prices fall; on the other hand, investors are at a huge loss, mortgage lenders reeling on the risk of defaulters. How does that happen?
Firstly, interest rises, putting homeownership out of reach for some, while at the same time, in adjustable-rate mortgages lead to defaulting and foreclosure for homeowners.
Secondly, a downturn or slow economic activity often leads to less disposable income, fewer jobs, and job loss. Such a situation causes a decline in demand for housing since people can not afford to buy homes.
Lastly, when demand is exhausted, an equilibrium is restored, slowing down the rapid rise of home prices. When house prices stagnate, those who depend on them to afford their homes may lose their houses, bringing more supply to the market.
It's heart breaking when the housing bubble bursts. Saul Loeb/AFP via Getty Images
Higher Interest Rates
As stated earlier, interest rate and house prices tend to have an inverse relationship such that when the interest is low, price appreciation occurs, and the reverse is also true. Interest rates play a huge role in market crashing. And if it’s going to happen soon, this will surely be a contributing factor.Rates Rise, Making Mortgages Very Expensive
Rising interest rates discourage borrowers from taking loans. On the other hand, home buildings will be affected too, costs will rise, and an immediate effect will be the supply of housing in the market falling.dHowever, a steady rise in interest rates will not cause much damage in the housing market, unlike a rapid rise. In 2006 before the housing market crash, many people were tied to interest-only and adjustable-rate mortgages that are initially cheap within the first few years, and then a reset that increases the monthly mortgage payment.
Unlike Conventional Loans, Adjustable-Rate Mortgages Rise Along With the Feds Fund Rate
Between 2004 and 2006, the Federal Reserve increased the rates rapidly. For instance, the top rate was 1.0 percent in June 2004 and doubled to 2.25 percent by December. It doubled again to 4.25 percent by December 2005. Six months later, the rate was 5.25 percent.Rising Number of House Flippers
A flipped home is basically bought, renovated, and sold in less than a year. Usually, the rise of home flippers further increases the demand for housing in the real estate market, resulting in a further increase in house prices. Surging prices are reflective of an asset bubble that could potentially burst.Home Flipping Played a Huge Role in the 2008 Recession
Speculators would buy homes, make moderate improvements, and sell them. In 2006, flips comprised 11.4% of home sales.According to Attom Data Solutions, in the third quarter of 2020, 5.1 percent of all home sales were bought for quick resale. That’s down from 6.7 percent of home sales in the second quarter of 2020. It’s also lower than the post-recession high of 7.2 percent in first-quarter 2019.
The decline in flipping is due to the reduced inventory of housing stock. However, Attom Data Solutions reports that the pandemic’s effect on flipping is contradictory and difficult to forecast.
There are many bad signals in the real estate market right now. CHANDAN KHANNA/AFP via Getty Images
The Alarming Increase in Unregulated Mortgage Brokers
In the events leading to the 2008 financial crisis, mortgage lenders fueled the asset bubble by issuing loans to high-risk borrowers. Many of the lenders opted to borrow against lines of credit, a totally different strategy than how banks and mortgage lending normally work by tapping into deposits.Non-Bank Lenders Are a Warning Sign of a Crash
The increase in non-bank lenders is alarming and a clear warning sign of what may come sooner rather than later in real estate. In 2019, they originated 54.5 percent of all loans. That’s up from 53.6 percent in 2018. Six of the 10 largest mortgage lenders are not banks. Three years ago, five of the top 10 were unregulated.The most worrying part about unregulated mortgage brokers is that they don’t have the same government oversight as banks. Making them vulnerable to collapse in case of anything going south in real estate.
A section of the Washington Post read: “Although observers say non-bank lenders are probably not engaged in the sort of risky lending that dragged down their predecessors, the business model still makes them vulnerable to a housing market downturn.”
Inverted Yield Curve
Prior to the recession of 2008, 2000, 1991, and 1981, the yield curve inverted. According to a definition by Investopedia, an inverted yield curve represents a situation in which long-term debt instruments have lower yields than short-term debt instruments of the same credit quality. When the yield curve inverts, short-term interest rates become higher than long-term rates.The Inverted Yield Curve Is Considered to Be a Predictor of Economic Recession
Usually, they draw attention from all parts of the financial world. A normal yield curve slopes upwards reflecting the fact that short-term interest rate is usually lower than long-term rates.Affordable Housing Crisis
The affordable housing crisis is caused by the imbalance in the market forces of supply and demand. A market boom in real estate will result in home prices skyrocketing. The scarcity of affordable housing across the country is always a sign that the market is in a bubble.
Be aware of the risk, and make a plan if you will be affected when the real estate market crashes. Hagen Hopkins/Getty Images
The Bottom Line
Is the Market Going to Crash
The market could crash if the combination of the above factors comes to pass. Already many are in play, and as the home prices sores, it’s evident that the U.S. housing market is overheating.The Pandemic Has Had a Mixed Reaction on the Real Estate Performance
While many people expected COVID-19 to crash real estate, there was a sudden surge in homes for sale. More homes for sale listings were done last year, with people rushing to buy homes in the suburbs. The rising homes for sale listings sparked speculators to enter the market, further pushing the demand up.Move to Prevent Foreclosures
Elsewhere, millions fell behind on their mortgage payments. However, the Consumer Financial Protection Bureau (CFPB) made mortgage servicing changes to prevent a wave of COVID-19 foreclosures.Consumer Financial Protection Bureau (CFPB) Acting Director Dave Uejio says, “The nation has endured more than a year of a deadly pandemic and a punishing economic crisis. We must not lose sight of the dangers so many consumers still face.”
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