There are growing concerns in some corners that we are in another price bubble and that there is a risk that home values will fall in the months to come. In January, the median home price in Virginia was up 12.5%, reflecting the sixth consecutive month of double-digit price growth here in the Commonwealth. Nationally, home prices are rising faster now than at any time since 2004. However, the situation we are in now is much different than the post-2004 world, and a housing bust is extremely unlikely.
What is a Price Bubble?
When people talk about a price bubble, they typically mean a run-up in prices fueled by speculation, which leads to prices above the fundamental value of the asset. Housing bubbles can occur at a local, national, or even global level. During a housing bubble, the rapid increase in home prices may be followed by a sharp decline, leaving many homeowners with negative home equity. This is what is meant by the price bubble “popping.”
So, Are We in a Price Bubble?
It is clear that home prices are rising dramatically in Virginia and across the nation. In fact, home prices are up much faster than other related indicators, such as income, employment, inflation, and rents. At the same time, an estimated 2.7 million homeowners are in a mortgage forbearance program and 10 million homeowners are behind on their mortgage payments. These trends are what have some people worried that the bottom may drop out of the housing market in 2021 and that we could see another housing bust.
Conditions in the housing market are radically different from what we saw during the last housing market downturn. The strong price growth in late 2020 and into early 2021 has been a result of economic fundamentals—strong demand, limited supply, and low mortgage rates. Demographics and the trajectory of the economy suggest that the housing market will continue to perform well and that price declines are extremely unlikely.
OK, But Exactly Why Should We Not Worry That Prices Will Fall?
There are several essential reasons to support the idea that we are not in a housing price bubble and that home values are not set to drop:
- Demand for housing, generally, and homeownership, specifically, is strong and growing. The large Millennial generation has entered their prime homebuying age as they reach their early to mid-30s. Demand will increase in 2021 as buyers who delayed purchasing during the pandemic get into the market, existing homeowners seek out larger spaces, and condo owners look to exchange their multifamily building for a single-family residence.
- Supply remains far below what is needed to meet that demand. While new construction has increased somewhat over the past few months, the number of new homes being built is still below the number of new households being formed. As a result, homeowner vacancy rates are at historically low levels as people are staying in their homes longer.
- Existing homeowners have better financial profiles. A key reason for the housing price bust back in 2006 was the inability of homeowners to make mortgage payments, often because they were offered loans with terms that they were not financially able to meet. The situation is very different today. Those who bought homes between 2010 and today have much better credit profiles than during the 2006 crash.
- A rush of foreclosures is unlikely. While the number of homeowners in forbearance or behind on their mortgage payments sounds like a precursor to a foreclosure wave, the market suggests otherwise. Existing homeowners have accumulated record levels of housing equity over the past few years. Furthermore, a homeowner having trouble making payments today could put their home on the market and find an eager buyer (or 10), meaning they would not have to resort to entering into foreclosure or a short sale.
These demand and supply trends suggest that the price growth we have been seeing lately can be explained by market fundamentals rather than runaway speculation. Home values will continue to increase in 2021, and even when mortgage rates rise, real estate prices will continue to climb. There is no housing bubble to pop.
We are expecting to see a slowdown in the pace of price growth and, frankly, that will be a good thing for the market. Affordability is a growing challenge in markets across Virginia and even with historically low mortgage rates, some would-be homebuyers are getting priced out. That affordability ceiling will limit demand for homeowners and slow price appreciation.
In addition, new construction will eventually begin adding to supply in a meaningful way. With an increase in available inventory, we should expect to see a price “correction” in terms of more typical rate of price appreciation in the years ahead.