Are we in a real estate bubble?

A house down the street from me recently went on sale with an asking price of $500,000. Which is crazy. It’s a nice neighborhood, but hardly opulent, apart from one or two places boasting sports cars and gated driveways. And the house going for a half-million is not one of those. In fact it’s arguably the plainest one on the block. 

Whether it will actually go for that price is of course debatable. But it’s definitely possible, and the fact that the owner would even try asking for that price speaks volumes about the current housing market. It’s a refrain being heard nationwide right now, especially in my hometown: home prices are crazy. And along with that refrain comes a certain menacing buzzword, casting its shadow over many a hopeful-but-harried homebuyer: bubble. 

Cue ominous organ music. 

Ok, maybe the word itself isn’t so scary. Actually sounds a bit childish now that I think about it. But still, a real estate bubble (or, more specifically, a popping bubble) is nothing to scoff at. When runaway housing prices eventually outrun demand, they whipsaw back down – leaving high and dry any poor suckers who had bought when prices were up. 

That’s a very scary prospect for anyone looking to invest in real estate. But is it actually worth fretting over right now? 

The short answer, in my opinion, is no. I think the recent spike in housing prices is driven by a very real spike in demand, rather than an artificial spasm of speculation that’s going to come crashing down all at once (like what happened in 2008). But even if it isn’t a bubble, today’s real estate market may well have other problems lurking within it.


Who’s buying houses right now?

There are two main reasons why people buy real estate: to occupy it as a resident or business, or to hold it as an investment. Really it’s a combination of the two for most people – you live in your house, but you probably also maintain and improve it with the idea of making a profit when you eventually sell it. 

As with any other asset, of course, there are also those who use real estate purely as an investment opportunity. At the risk of oversimplifying, it was excessive speculation by such investor types that caused the epic crash of 2008, and average-joe resident homebuyers just got unluckily caught in the crossfire. 

That does not appear to be the case today, however. There’s a lot of data indicating that today’s rush of real estate demand isn’t really driven by investor speculation. Rather, it’s mostly people who need a place to put all their junk and can now afford to get one.

“Well wait,” you might ask, “are you telling me that there are literally more people wanting houses now than there were before?” 

Yup, that’s exactly what I’m saying. The millennial cohort – second-largest after the boomers – are finally moving out of their apartments and parents’ basements. In fact, the oldest millennials are already pushing 40. Many have several kids, multiple cars, and a lot of junk they need space for. Thanks to rock-bottom interest rates in the wake of Covid, those who didn’t already have homes can now afford to get one. 

Or at least they can in theory. More on that in a minute – first, here’s some of that aforementioned data:

Across the last decade, the rate of homeownership (that is, the percentage of homes that are owned by their occupants) has been on a bit of a rollercoaster. It’s seen a healthy rebound after an initial nosedive, and is now sitting comfortably above the decade average at 65.6%.

That's all well and good. But then what about homes that are unoccupied? How do we know there aren’t a bunch of those being snapped up by speculators and artificially inflating prices? Well, I’m glad you asked! 


If speculators were snarfing up properties now like they had been in 2008, then presumably the vacancy rate would be going up. But instead we find that it’s continued its steady downward march to a 10-year low.

What these two charts together tell us is that the overall inventory of homes is getting snapped up – very efficiently – by resident homeowners rather than investors or property managers. That strongly suggests that this is not a bubble… but there are a couple of other red flags yet to consider.


Should they be buying houses right now?

The term “homeowner” is a bit deceptive, as it includes people who are still in the process of paying down their mortgage – and who, therefore, still present the risk of default. So this raises another potential concern: are banks being responsible with the mortgages they’re doling out? Or are they making bad bets on borrowers who won’t actually pay on time, or at all?

Once again, the data are encouraging. More and more of today’s homeowners are better equipped to pay their mortgages, as indicated in the chart below: 

Basically, the average homeowner today has quite a bit of their paycheck left over after their monthly mortgage payment – much more so than they did fifteen or even ten years ago. In other words homeowners are, on average, better qualified to own a home than they have been for a long time. Here’s one more chart that really confirms this: 

The vast majority of mortgages today are going to people with exceptional credit scores, which was emphatically not the case twenty or even fifteen years ago. Again, this is great news because it indicates a stable home market built on genuine buying power. 

In other words: NOT A BUBBLE.

But even if the housing market isn’t artificially inflated and about to blow up in our faces, there’s another, very different reason for concern. It’s best summed up in three little words: barriers to entry. 


Who isn’t buying houses right now?

Remember how I said a minute ago that, thanks to ultra-low interest rates, millennials who perhaps couldn’t afford a home previously are now able to? And then I said "in theory?" The chart above hints that the practical reality may not be quite as rosy as the theory. 

On the one hand, it’s great that more homes are going to better-qualified buyers. But on the other, we all know that homeownership is instrumental for the lower and middle classes to build up wealth. Although we want banks to be discriminating and loan responsibly, we also don’t want them to block out people who could make the jump to homeownership if given the opportunity. 

People, for example, with more mid-range credit scores. So here’s yet another question: where did all those lower-credit borrowers disappear to? Did they get crowded out of the market, or did they just graduate to the high-credit ranks? 

Well… not to be a cynic, but one explanation seems much more likely than the other. Especially when we consider the last major piece of the puzzle. We’ve been talking almost entirely about the surge of housing demand – but what about housing supply? 

Yeah. Here’s where the bad news comes in. Although housing demand has been increasing steadily over the last decade or so, the overall inventory of available homes has been decreasing over that same period. Hence, for example, the lower vacancy rates – less property is sitting vacant because there’s just less property, period. 

And then Covid kicked all of this into overdrive. While new home purchases spiked in response to the low interest rates and cash influx of the CARES Act, the lockdowns caused labor and supply chain shortages that throttled the construction industry at the same time. This all came on top of a long-term slump in new construction that had already been happening since the 2008 recession. 

With such a high demand for homes coupled with such limited inventory, both sellers and lenders can afford to be very discriminating. Sellers demand higher prices, lenders demand higher credit scores, and the barriers to entry for homeownership go way up. In short: as much as demand for homes has accelerated, the cost has accelerated much faster – and that means people are probably getting shut out.


So… should we be worried about the housing market?

Yes and no. Even though the housing market clearly isn’t in a bubble at the moment, it’s not exactly healthy either. It’s a great place to be if you’re a current homeowner, and downright fantastic if you’re selling. But would-be homebuyers in the middle and lower class are basically out of luck, at least for now, and that’s definitely cause for concern.  

If they remain out of luck for the long term, there will be consequences. To reiterate: a higher barrier to entry for homeownership makes it harder for those who aren’t already wealthy to start accumulating wealth. If left unchecked, that in turn means more shrinkage of the middle class and a “tale of two cities” scenario where the rich get richer and the poor get poorer. 

I probably don’t need to explain the many, many reasons why that would be bad for everyone. 

Unfortunately (as with any macroeconomic phenomenon), there’s not a lot that you or I can do about it right now. It’s largely up to the construction industry to ease the inventory shortage, but even they can’t do much right now with the labor shortage and supply chain problems they’re currently facing. 

Hopefully, one or both of two things will happen soon. Either the labor and supply situations will improve, allowing construction to get back on track; or, some innovation in the housing industry will introduce a way to work around those shortages, again allowing construction to get back on track.

In the meantime, if you’re selling, then congrats! Take advantage of this opportunity while it lasts. If you’re a homeowner, the world is your oyster: you could probably make a killing right now if you’re up to the hassle of selling, but there’s nothing wrong at all with sitting out the drama and counting your blessings. 

And if you’re buying, well… my sympathies. I won’t say you should despair just yet – that depends on the vagaries of your personal situation and the particular real estate market you’re in. But it may be wise to delay your plans and hold out for better days. They will come eventually. 

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