Is This A Bubble?

Editor’s Note: Dennis Fassett is a former corporate finance executive turned real estate investing “Cash Flow Mercenary.” Dennis specializes in single-family and multi-family cash flow properties and thoroughly enjoys assisting his fellow investors with their own strategies, including how to buy your first apartment building.

As an ongoing contributor to Mogul’s “Market News Updates,” Mr. Fassett provides us with his own unique, lively, and thought-provoking commentary on the timely industry news and events of today that are impacting our industry. And be sure to check out his other super-helpful Market News Updates. For now, enjoy...

From Dennis Fassett, Cash Flow Mercenary...

One of the consistently hot topics at REIA meetings these days is “The Real Estate Bubble.” More specifically, are we headed for one, and if we are, what are the signs to look out for?

Because of that, I read a lot on the topic, because ideally I’d like to be ahead of the curve and not be a loser in the game of musical chairs that a bursting bubble would cause.

An article on CNNMoney.com had a surprisingly good write up on this, and they gave their opinion as to why the market is so tight and why this isn’t another massive bubble.

The article said that it's been a long and uneven road to revival for the housing market. But things have been heating up for the past few years. Home prices took off in 2012 and went on a tear in 2013. And while the double-digit growth has slowed somewhat, prices are still heading higher.

And in February, prices rose 4.2% from the year prior according to the S&P/Case Shiller U.S. National Home Index.

Some local markets are on fire, with bidding wars and offers above asking price becoming common.

bubbles In San Francisco for example, 74% of homes listed earlier this year, sold within two months of hitting the market. The median asking price there was $1,099,000. Several other areas in California, along with Seattle and Salt Lake City are experiencing similar real estate booms. And home prices in Denver and Dallas have exceeded the levels hit during the housing boom.

The article cautioned, however, that if prices continue to outpace inflation and income in these areas, that can eventually become a problem.

And they quoted another Captain Obvious, Keith Gumbinger, vice president of HSH.com, who stated that:

"Price increases -- even in the most desirable places -- can't continue to outstrip income growth forever," … "At some point, no one will be able to afford a home.”

Yeah, thanks for that bit of astute analysis.

Three Keys Points

The article went on to offer some pretty good analysis as to what’s driving prices higher.

They pointed to three key factors impacting the market:

Homeowners aren't selling

Current homeowners list their home to either trade up or downsize, opening up inventory for first-time buyers to come in. One can't happen without the other.

"The whole train has to move at the same time," said Gumbinger.

But current homeowners aren't flooding the market with "For Sale" signs. Some are worried they won't be able to find a new house or they're still waiting to recoup their home's value lost in the crash.

"Homeowners who would be considering selling could still be underwater or still in too low of an equity position," said Gumbinger.

Existing home sales have increased for seven consecutive months, but David Crowe, chief economist at the National Association of Home Builders, said it's not enough:

"Without additional inventory on the existing side, the first-time homebuyer is boxed out."

Builders aren't building

Builders have been cautious during the recovery, since they need to know homeowners will upgrade to the houses they build, said Crowe.

According to Crowe, a normal housing market has 1.6 million new single- and multi-family homes built annually. Last year, the market hit a million, but single-family homes made up just 700,000, when it's typically a little more than a million.

Lenders still aren't lending

Strict lending practices have made it harder for buyers to secure a mortgage since the bubble burst in 2008. And while banks have loosened up a little recently, lending is still significantly tighter than it was before the housing crash.

That's not necessarily a bad thing, but Crowe thinks standards are still a little too tight:

"Underwriting standards have been tightened up beyond what is necessary," said Crowe. "It's an overreaction to clearly loose standards in the middle of the last decade."

Tight inventory and rising prices can be potential warning signs of a bubble forming, but experts say it's too early to tell.

So Is this a Bubble or Not?

"It's not obvious yet," said economist Robert Shiller, who helped create the S&P/Case-Shiller Home Price Index, on a potential bubble.

If there is one, it's a different type of bubble than the one in 2008. While supply and demand helped inflate that bubble, the demand was enhanced by loose mortgage lending practices that sometimes pushed buyers to take out loans they couldn't afford.

"That bubble was fostered by a finance-related push," explained Gumbinger.

Today's rising prices are fueled by actual market forces, backed up by real money. "You don't see all those things that would create unsustainable demand," he said. "It's a better qualified marketplace."

“Any potential bubbles at this point would be limited to specific markets,” he added. "There are marketplaces that are beholden to certain industries and if those change, that could mean local changes to that market. At the end of the day, all real estate is local."

So these guys don’t think there’s a bubble forming. And I have to say their analysis is pretty compelling.