The New Housing Bubble Illusion

Before you go, we thought you'd like these...
Before you go close icon

Home prices are once again shooting through the roof. Does this mean we're in the early stages of yet another housing bubble? In a word, no.

Housing prices are rocketing higher
Data released this week by Standard & Poor's showed that prices in 20 of the nation's largest metropolitan areas increased by 12% in June compared to the same month last year. For the record, it was the third consecutive month of double-digit year-over-year gains.

At first glance, you'd be excused for concluding that this trend must be the harbinger of yet another housing bubble. Indeed, the last time home prices increased in consecutive months by an analogous margin was the period between August 2002 and May 2006. That is, just as the previous housing bubble was inflating.

"The average rate at which median new home sale prices in the United States has been escalating is over 17% faster than the average rate at which median new home sale prices rose during the initial inflation phase of the first U.S. housing bubble," a blogger at Seeking Alpha warned in an article about the "second U.S. housing bubble."

But while this sounds ominous, the reality is that it's also incorrect. As R.D. Trinidad, president of Hoff & Leigh, a commercial real estate broker based in Colorado Springs, CO told me: "I think a near-term bubble is over-hyped."

The difference between today and the last bubble
Again, to be clear, home prices are indeed rising at a rapid clip and, as Trinidad pointed out, "the residential housing market moves in cycles, alternating between periods of boom and bust. It very rarely remains at a stable equilibrium."

But prices are shooting higher for a far different reason than they did in the period between 2002 and 2006. That is, supply in both the new and existing home markets remains exceptionally low. The inventory of new homes for sale equates to only a 3.9-month supply. This is the lowest level in nearly a decade. And the inventory of existing homes, although higher, is in the same boat, equating to a 5.2-month supply.

So, why is supply so low?

In the new-home market, it's because homebuilders such as PulteGroup and Toll Brothers are still in the early stages of ramping construction back up since the bubble burst six years ago. In 2005, Toll Brothers, the nation's largest luxury homebuilder, was selling 2,800 homes a quarter. Today, it's selling less than 900 over the same span. And the picture is virtually identical at PulteGroup, where current production is at less than a third of its former high.

As my colleague Morgan Housel has pointed out, part of the problem here relates surprisingly to a labor shortage in the construction industry -- I say "surprisingly" given the still-elevated unemployment rate. "They can't find enough people to work in housing, that's the only thing holding it back right now," said hedge fund billionaire David Tepper at the time.

Meanwhile, supply is low in the existing-home market because a large swath of homeowners remain underwater on their mortgages and are thus unable to list their homes. Depending on the data source, anywhere between 19.8% and 25.4% of mortgages have negative equity.

"These homeowners owe more on their mortgage than what their house is currently worth, which means in order to sell it, they would have to come up with additional money at the time of closing to pay off their loan," Zillow's senior economist Svenja Gudell explained to me last month. "Since many homeowners are not in a position to do that, they cannot list their homes, greatly restricting the supply on the market."

The residual impact of this shadow supply, if you will, is that it should act as a natural governor on prices. As prices increase, more homeowners will achieve positive equity and be freed up to list their homes. As they do so, supply will increase, which, in turn, will decrease the pressure on prices.

In fact, we're already seeing this. The chart below, which I included in an article yesterday, shows the National Association of Realtors' pending home sales index. As you can see, while the index value was slightly lower in June compared to May, both months were markedly higher on a year-over-year basis. In addition, recent data from CoreLogic showed that a total of 850,000 properties returned to positive equity over the first three months of the year.

The bottom line
At the end of the day, while it's admittedly tempting to be attracted by the siren song of alarmism, there's simply no reason to be concerned about a new housing bubble right now, or for that matter, any time over the foreseeable future.

To read more about why fears of a housing bubble are without merit, check out Morgan Housel's recent discussion on the topic here.

Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

The article The New Housing Bubble Illusion originally appeared on

John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

People are Reading