8 states with the biggest real estate bubbles

When most people read the term "real estate bubble" or "housing bubble," they likely think of the 2007-2008 financial crisis. However, the common man doesn't know much about bubbles beyond their relationship to the recent economic collapse.

In a bubble, the price of an asset — be it housing, stocks or even tulip bulbs — is high because investors believe the selling price will be high or even higher tomorrow. Therefore, demand and price for the asset both increase. The problem is that the demand eventually decreases as supply increases, which leads to a decrease in prices and POP — the bubble bursts, sending shock waves throughout the economy.

Today, most experts agree that, on a national level, we are not in a real estate bubble. The absence of nationwide or statewide housing bubbles doesn't mean they're not forming, however, or that they don't already exist within some states on a more local level.

GOBankingRates analyzed housing market data and key economic indicators and contacted several real estate experts to determine states that could be on the cusp of a housing bubble. Based on the information found, the following eight states — ordered from lowest to highest population — are the most at risk for a real estate bubble. Consider this information carefully before buying a home in one of these states.

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8 states with the biggest real estate bubbles
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8 states with the biggest real estate bubbles

8. California

California was one of the states most affected by the 2006 real estate bubble and collapse. Today, the state could be experiencing another because housing supply is so constrained that it is pushing affordability out of the reach of buyers, Gower said.

“The number of homes on the market is, remarkably, 16 percent less than last year. Current inventory is down to three months or so, versus a normal level of seven to eight months,” he said. “This adds to upward pressure on pricing.”

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California: Short Supply, Soaring Prices

Several factors are combining to make this worse. Specifically, it is becoming too expensive to move. “Prop. 13 keeps taxes low for long-term homeowners and serves as a disincentive to move. [And the] aging population wants to age in place,” Gower said. More homes are being rented, which removes stock from the market for homeowners — reducing supply and driving up prices.

“But pricing is increasing so much that fewer and fewer people can afford to buy,” he added. “[It] may reach as low as 25 percent homeowners in the state.” Not surprisingly, price-to-income ratios are way beyond the 3.5 price-to-income ratio that is considered normal. According to Zillow data, these California cities are among the most lop-sided:

  • Napa: 7.5
  • San Diego: 7.6
  • San Luis Obispo: 8.6
  • San Francisco: 9.1
  • San Jose: 9.23

The Los Angeles-Long Beach-Anaheim metro area has an approximate price-to-income ratio of 9.23, slightly higher than San Jose’s. However, Santa Cruz takes the cake, with home prices that are roughly 11 times the median household income. In all these cities, price-to-income ratios are significantly higher than their historic averages.

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(JohnnyH5 via Getty Images)

7. Texas

Texas as a whole is not in a bubble, said Chandler Crouch, founder and principal broker of Forth Worth, Texas-based Chandler Crouch Realtors. However, some cities and regions are displaying symptoms of a real estate bubble — especially those overly dependent on one or two industries for livelihood, he said.

“Midland is in a bubble — their economy is primarily fueled by oil,” Crouch said. “Houston, Austin, San Antonio are borderline.” All of them, however, have housing markets that are seriously overvalued.

(dszc via Getty Images)

Texas: Markets Are Too Overvalued

According to Fitch Ratings, home prices in Austin and San Antonio are overvalued by almost 20 percent. By comparison, at the peak of the housing bubble, Austin was overvalued by about 5 percent and San Antonio about 4 percent. Dallas and Houston also are more overvalued than they were at the height of the last bubble.

As in Tennessee and Florida, home flipping is on the rise in Texas. According to RealtyTrac, markets in Texas zip codes have recorded that at least 20 percent of all homes sales from 2016 were home flips.

Not surprisingly, a couple of Texas markets suffer from major housing affordability issues. According to RealtyTrac, Dallas and Austin rank among the top 20 metro areas for the lowest affordability index as of second quarter 2017, hardly a distinction to brag about.

6. Florida

Florida is one the “Sand States" that was hit hard during the housing bubble and crash. Recently, home prices have crept back up, thanks to hot housing markets.

“Real estate is an asset class that is extremely susceptible to bubbles because it has no intrinsic value,” said Philip Lang, COO and co-founder of TripleMint, a full-service real-estate brokerage. “Its value derives from the relative prices of other properties in an area.”

If a housing market heats up, it can ignite neighboring markets, boosting their home prices by proximity. On the other hand, if home prices decline in one market, they can drive down prices in other markets in the area, like setting off dominoes.

According to RealtyTrac, house flipping in the U.S. is reaching record levels that have not been seen since 2006 — the peak of the last housing bubble. And Florida is one of the main culprits.

(TraceRouda via Getty Images)

Florida: Home Flipping Up and Sales Volume Down

Home flipping rates in Florida metro areas are among the highest in the country, with flipping rates in Tampa-St. Petersburg, Deltona-Daytona Beach-Ormond Beach and Jacksonville being the most alarming. Money made from flipping houses set new records in 2016, fueling competition and further increasing the rate of flipping even more.

There are other worrying signs, such as a sudden decline in sales volume. In Miami, sales of single-family residences and condos are plummeting, while new homes are overwhelming the market with supply. "[Home] prices will continue to rise as the momentum of the market keeps them on the uptick,” Gower said. “But then there will be a precipitous drop.

“It’s a bit like being one of the only ones still dancing when the music stops,” he said. “You don’t realize it until you suddenly realize there is no soft landing for you.”

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(ntzolov via Getty Images)

5. Washington

Washington is no stranger to rising costs and prices. For example, Seattle’s cost of living is skyrocketing, so much so that nearly half of the area’s millennial residents are seriously considering an exodus.

Home prices for all homes in Seattle have risen immensely. In the last five years, the median listing price shot up from $349,950 in May 2012 to $650,000 in May 2017 — nearly 86 percent. According to RealtyTrac, every county in the Seattle housing market experienced severe declines in affordability between first and second quarter 2017.

(Furchin via Getty Images)

Washington: Incomes Can’t Match Home Appreciation

Median incomes in major markets like Olympia, Spokane, Wenatchee and Seattle are lagging behind the increase in home prices, which are growing faster than the historic average. Bellingham is one of the worst cases, with a price-to-income ratio of about 5.8, which is 72 percent higher than the past norm.

The local economy is booming, yet wage growth cannot keep pace with home appreciation. The supply of homes is so low that it continues to push home prices higher, beyond the gains made in income. For example, median home prices in King County, Wash., home to the Seattle metro area, rose 15 percent year-over-year versus only a 3 percent increase in average weekly wages.

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4. Tennessee

Tennessee is seeing some hot housing markets in its cities — maybe too hot. One key thing to be aware of is the extent of activity in a market of speculators, or house flippers, said Adam Gower, Ph.D., host of the National Real Estate Forum podcast and a 30-year real estate veteran. “If you see a market where there appears to be more fix-n-flippers than actual home-owners, the chances are you are in a bubble."

According to a new report from RealtyTrac, Memphis and Clarksville, Tenn., recorded the highest home flipping rates as a percentage of all home sales. Tennessee ranks among the top 10 states with the highest return on investmentfrom flipping houses. And there are additional factors that make real estate bubbles a concern.

(csfotoimages via Getty Images)

Tennessee: New Home Construction Skyrockets

In Nashville, housing demand is fueling record levels of home construction. In the first quarter of 2017, new home construction soared to levels not seen in more than eight years, according to Metrostudy, a provider of market information to the housing and residential construction industry. Finished inventory in Nashville now stands at its highest level in five years, but the finished inventory months supply remains very low because of continued strong demand for new homes. The logical solution is to build more supply, but this can help contribute to housing bubble conditions.

The nature of real estate cycles makes homes behave very differently than most other assets, particularly when it comes to supply and demand. During the expansion phase of the four-part cycle, demand for housing leads to declining vacancy rates, and new construction increases to match supply to demand.

But it doesn’t take an expert to know that homes take a while to build — from getting the initial building permits all the way to a finished lot. By that time, the demand for housing is often gone, satisfied by developments in the market before the newly constructed homes could even reach the market.

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(rdegrie via Getty Images)

3. Colorado

Like Oregon, Colorado’s housing market is overvalued, according to Fitch Ratings. But why is overvaluation important to real estate bubbles?

People believe that the asset, often real estate, is going to become more and more valuable in the future. If it becomes more valuable because it produces more income, that is one thing," said David Reiss, a real estate expert and law professor at Brooklyn Law School. But if it becomes more valuable just because people think it is going to become even more valuable, that is another. At some point, the merry go round stops and the current owners are left with an asset worth less than what they purchased it for.

In Colorado, home prices in major markets like Fort Collins and Boulder are not just overvalued, they’re more overvalued than they had been at their peak during the 2005-2006 housing bubble, hardly an encouraging sign. Making matters worse, incomes are failing to keep up with rising price.

(KaraGrubis via Getty Images)

Colorado: High Prices and Low Affordability Index

Several Colorado metro areas are seeing price-to-income ratios above both the national level and their historic averages. The median home price in Denver and Fort Collins are roughly five-times the median income. In Boulder, the home price-to-income ratio is even higher at 6.6 and is more than 100 percent higher than the historic average.

To be clear, high home prices don’t necessarily equate to a bubble, said Jeff Shaffer of McKinley Partners, a real estate private equity firm. “A typical bubble starts with high prices causing capital to start flowing quickly into that space because of attractive returns. So high housing prices may spur a bubble down the road, especially in markets like Denver, where you see a lot of new home development in the pipeline to open up,” he said.

According to RealtyTrac, a real estate information company and an online marketplace for foreclosed and defaulted properties, Denver County has the nation's lowest affordability index as of second quarter 2017, meaning it has the least affordable prices compared to historical averages. Adams County and Arapahoe County, both in the Denver metro area, also rank among the worst for housing affordability.

(marekuliasz via Getty Images)

2. Oregon

Price-to-income ratio is useful in real estate market trends for comparing where current home values stand today versus values in the past. In this regard, Oregon stands out, possessing several cities where price-to-income ratios are far above past norms.

Over the years, home prices usually move in step with inflation, population and economic growth. If the price-to-income ratio rises, that means houses are becoming too expensive for the population’s income to sustain. Portland, one of the major U.S. cities whereresidents aren’t making enough money to live comfortably, is experiencing this first-hand. But there are others.

(JamesBrey via Getty Images)

Oregon: Home Prices Growing Too Quickly

According to Freddie Mac, many analysts consider a price-to-income ratio of 3.5 to be a healthy norm. Several of Oregon’s major cities have home price-to-income ratios well above this ratio, including:

  • Eugene: 4.9
  • Portland: 5.4
  • Bend: 5.67
  • Medford: 5.68
  • Corvallis: 5.8

In all these cities, home prices are growing faster than incomes and at a rate far higher than usual in the past. According to Zillow data, when examining the period 1985 through 1999 — thus, before the 2000s housing bubble — all five of these cities had ratios that were more than 50 percent higher than their historic average.

What doesn’t help the assessment is that Fitch Ratings — which specializes in credit ratings and research — found that Oregon’s housing market to be overvalued by close to 11 percent.

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1. Nevada

The housing crash hit Nevada hard. Along with California, Florida and Arizona, Nevada is part of the “Sand States,” a group of states that experienced some of the highest rates of home appreciation in the lead-up to the 2007-2008 bubble, according to the FDIC. After rates peaked in 2004, Nevada home prices plummeted, with cities like Las Vegas witnessing prices fall by a staggering 33 percent in 2008.

Nevada’s recovery from the crash, like the U.S. in general, has been uneven. Las Vegas, for instance, took an immense beating, and home prices today are far away from their pre-recession levels. And yet in some ways, Las Vegas is back to its old ways. According to Las Vegas Business Press, home prices have been growing faster than the national average and faster than markets like Los Angeles, Phoenix and Washington, D.C. But the pace of it is straining incomes and their ability to cover the increase in prices.

(trekandshoot via Getty Images)

Nevada: Home Price-to-Income Too High

Household incomes play a major role in the development of housing bubbles but also help in identifying them. “One simple way of evaluating a bubble is looking at home prices in a market compared to local incomes,” said Brian Davis, a real estate investor and co-founder of Spark Rental, which provides rental automation and education services to landlords, property managers and renters. Known as home price-to-income ratio, this relationship can reveal a lot about a housing market.

“A frenzied mentality among buyers might drive prices up beyond what’s tenable over the long term, for a given city,” Davis said. “Historically from 1950-2000, median home values have been roughly 2.2 times the median income. Today, that number is roughly 3.36 times higher, 50 percent higher than the historical average.”

Price-to-income ratios in markets like Reno and Las Vegas run higher than their historical averages, according to Zillow.

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