Are We In Another Real Estate Bubble?

May 15, 2018

Are We In Another Real Estate Bubble?

  • The data resembles 2007, but there are other factors to think about.


Recently, I was listening to an interview with Robert Shiller where he was explaining how they predicted the 2000s housing bubble. This got me thinking so I went to dig deeper and found the following chart.

Figure 1: House prices have passed through the same spike as they did in the 2000s. Source: FRED.

House prices are now above the 2007 level. The spike in prices has been similar to the one in the 2000s, and it looks like house prices can only go up.

Just to make things sweeter, a recent Wall Street Journal article described how house flipping is hot and Wall Street is investing more and more in the business where KKR & Co invested in short term house flipping loan products—so called flip bonds—that yield between 8% and 12% per year. The funny thing with these flip loans is that the lender estimates the borrower’s risk by their past flipping success not even acknowledging the influence of the market and rising home prices. Falling home prices? Come on, the last time that happened was centuries ago… (2012, but allow for some irony).

So, we have home prices rising, the flipping business is attracting more and more money, and everyone expects home prices to continue to rise. Let’s take an objective look at the matter across the U.S. and Europe to see what the housing market risks are. This will also help you make the decision on whether you should wait with buying or jump into this hot market if you are a first time buyer, or, if you own real-estate, whether you should sell.

Why Are Home Prices Rising So Fast Again?

Real estate prices are driven by demand and interest rates. As the unemployment rate is at historical lows, many can now afford a house and the low interest rates enable them to do so, or at least make it seem cheap to do so.

Figure 2: Average 30-year mortgage rate in the U.S. Source: FRED.

So, 30-year fixed mortgage interest rates in the 1990s were around 8%, while now the average is 4.55% which is already 100 basis points higher than it was in 2016 when it was at 3.5%. So, when someone looks to buy a home, they look at how much they can afford mortgage-wise and that depends on interest rates.

Let’s use an average household income of $59k without any kind of debt and an available down payment of $50k. According to bankrate, the average affordable home amount is $253,000 (loan $203k). If I calculate the affordable home amount with an interest rate of 8.5%, the affordable home amount declines to $184k (loan $134k – 34% decline). Consequently, it’s logical that home prices alongside inflation have doubled since 1999.

As interest rates go up, it’s likely that home prices come under pressure. However, don’t expect that to happen linearly. High employment allows for more demand for homes, problems will arise only when there is a recession and much lower demand for homes, and a multiple of factors converge. Thus, there could be an inflection point, but there is also another side of the story. Let me first discuss Europe and then the other scenario.


The situation isn’t better in Europe where interest rates are also historically low. For example, in the Netherlands, where you don’t need a down payment at all to purchase a home, you can get 30-year fixed rate mortgages with interest rates of 3%.

Figure 3: 30-year fixed mortgage rates with no down payment – home financed 102%. Source: Hypotheek.

Needless to say, home prices here in Europe have spiked too thanks to the extremely low interest rates.

The question remains, are we in a housing bubble?

The home builders say no because their confidence level is back to pre-crisis levels.

Figure 4: NAHB/Wells Fargo National home index. Source: NAHB.

High employment, lower taxes which brings more money, and higher demand is one way of looking at it and there is, then, no bubble in sight.

However, if we take an opposite perspective where interest rates rise, a normal recession comes along, and home prices return to inflation growth levels, the housing market is in a bubble again. The funny thing with bubbles is that people call it a bubble only when it bursts.

Figure 5: Home prices are again diverging from inflation. Source: FRED.

If mortgage interest rates rise to normal historical levels of around 8%, we will definitely see a 25% decline in home prices and the latest spike will be called the quantitative easing housing bubble. If interest rates don’t rise to historical levels and the economy continues to slowly expand or inflation protects home prices from declining, we might again see rising home prices even if a small recession comes along.

So, as always, there is a possibility for two scenarios and this doesn’t really help with your decision making, but please don’t listen to those who know what will happen because nobody knows what will happen. The only thing we can do is to estimate what can happen and what would be the consequences to us in both scenarios, and that is the only way to make proper investment/home buying decisions. However, there is a most likely case to take into account.

The Most Likely Case With Home Prices

Here are a few things to think about when discussing home prices:

  • My home mortgage is financed by Aegon, the global insurer.
  • Pensions funds invest in securitized mortgage bonds in order to get some kind of return in this low interest rate environment.
  • Governments that have high debt ratios collect taxes based on home values.
  • Home prices have surpassed their bubbly 2007 level already.
  • Inflation is around 2% per year.
  • Government debt levels are extremely high from an historical perspective.

All of the above indicates that nobody—from insurers, to pension funds, and governments—can afford much higher interest rates and lower home prices as another 2007-2012 downward spiral would be very painful. Lower home prices would bankrupt many insurers, cut lots of pensions, and lower government tax income.

Therefore, it’s highly likely that politicians and central banks will do whatever it takes in the future to keep home prices and asset values high as our modern debt burdened economies depend on low interest rates, positive inflation, and high asset values.

There might be short term fluctuations, but I still see real estate as one of the hedges in this market. As it’s impossible to time what will happen, one must analyze it all from a personal perspective. I hope I have made the decision-making process more objective by sharing the above.