In this article:
- News outlets and economic pundits have been talking about an impending housing bubble and with the looming recession, it’s anticipated that the bubble will finally burst.
- The effect of the ongoing pandemic has led to changes in people’s purchasing power and affordability of their mortgage installments. But house prices are soaring despite a lull in demand.
- An analysis by Bloomberg Economics shows that 19 OECD countries have combined price-to-rent and home price-to-income ratios that are higher today than they were ahead of the 2008 financial crisis — an indication that prices have moved out of line with fundamentals.
There is a housing bubble across many countries in the world, including USA and Canada, and experts are saying it’s on its way to a burst.
The effect of the ongoing pandemic has led to changes in people’s purchasing power and affordability of their mortgage installments. But house prices are soaring despite a lull in demand. This has created a bubble, where subsequent decreases in pricing could shuffle the economy toward another recession.
What’s concerning is that this is happening in an era of post-pandemic inflation, unemployment, stock-market disturbances, and a war taxing the resources of two continents. If the housing bubble bursts, it could be steeply downhill for a lot of companies and middle-grade earners around the world. It is time to take a closer look at the warning signs.
Housing Bubble and the Real-Estate Market Engine
When gaps between rents and incomes grow so large compared with home prices, it leads to a price correction. High gaps signal that house prices and rents are moving beyond the affordability range of single and family earners. This leads to low demand in the market. People stop buying houses as they can no longer afford them. It can also lead to defaults on mortgage payments for new homeowners, causing banks to swoop in for foreclosures. Sellers will lower prices in this scenario when interested buyers keep getting away, especially when mortgage applications are rejected due to income gaps. Ultimately, waves of lowering prices start taking over different pockets of the market (read different regions of a country or continent).
Are We on the Cusp of an Actual Housing Bubble?
An analysis by Bloomberg Economics shows that 19 OECD countries have combined price-to-rent and home price-to-income ratios that are higher today than they were ahead of the 2008 financial crisis — an indication that prices have moved out of line with fundamentals.
In the chart created by Bloomberg Economics, we can see that several countries that are ranking high on the risk of recession have extremely large ratios of house prices to rents and incomes. This shows huge gaps between purchasing power or renting power for single-family housing units with mortgage and rent rates.
From Housing Bubbles to Economic Slumps
When price correction kicks, it reduces the existing wealth of homeowners. If you are trying to sell your house, you will now get a much lower return on it. Even without selling, your assets now have a lower gross; you have lost a chunk of your wealth balance.
Price correction creates a cycle. Buyers will suddenly feel unsure of whether they want to buy a house. They could revise their decisions and move on to a different area where prices have not suddenly dropped.
As the wave catches on, the market on the whole is losing money. Business is slow, sales are less frequent, and closings happen at far lower prices than the norm. This affects future development and construction in the region. It can also influence the rents if incoming renters lose their confidence because of the real-estate slump.
From Local Housing Bubbles to World Economy
Construction and sales of property are huge economic forces around the world. Markets are connected by multinational real-estate constructors, developers, and management companies. The banking system and stock exchange are also attuned to real-estate markets through loans, mortgages, and interest rates.
When price correction enters its deep phase in several countries at once, as the Bloomberg chart warns, the ripple effects on the world economy would be real. The affordability versus income gap is bigger today than we were seeing before the market crash in 2008.
When there is a simultaneous slump in both business and financial cycles around the world, that’s when the world hits the brink of its next economic recession.
Interest Rates and the Housing Bubble
When things swing too high, they got to come down. It’s only when the pendulum has swung too far on the side of ballooning house prices, mortgages, and rents, does it suspend mid-air to begin its journey to a market slump at best and a recession at worst.
The Federal Reserve has implemented several interest rate hikes this year in a spirited attempt to cut down extreme inflation. However, this policy has also had a more than doubling effect on mortgage rates since the start of 2022.
Interest rate hikes are reported in basis points. A single basis point is one-hundredth of 1%. In the financial world, a raise in basis points still translates to considerable differences in rates, mortgages, and prices due to the big money involved in real estate. So far this year, US Federal Reserve has increased interest rates by 75 basis points, which translates into remarkable increases in the average contract rate of a 30-year, fixed-rate mortgage. At a global level too, the Bloomberg report informs that over 50 central banks have raised interest rates by at least 50 basis points in a single stroke this year.
Mortgage Loans and the Housing Bubble
Rising interest has an immediate and direct effect on real estate. The Mortgage Bankers Association reported in October 2022 that the average interest rate on the most common type of home loan in the US was at its highest level since 2006.
Joel Kan, an MBA economist, reports that the current mortgage rates are exactly double what they were same time last year, indicating a huge spike in a short amount of time. Taking the seven weeks of consistent drop in loan volumes altogether, the corresponding increase in basis points amounts to a whopping 130.
CNBC reports that mortgage credit availability has hit its lowest in nearly 10 years. The likelihood of mortgage approvals and the loan amount figures that are approved have consistently fallen throughout the last seven months. This leads to big drops in demand for mortgages. The evidence comes from the Mortgage Bankers’ Association, which reported a 14%+ drop in the volume of mortgage applications in October this year, to a level that is lowest since 1997.
"Housing bubble" Today's editorial cartoon by David Parkins. More cartoons: https://t.co/cqCBmttKtX via @GlobeDebate pic.twitter.com/DlXPIpWZiF
— The Globe and Mail (@globeandmail) June 13, 2016
Mortgage finance experts are warning that the mortgage loan market is fast approaching its trigger rate. For any homeowner, the trigger rate will push into the inability to pay the monthly payments. Rob McLister, a mortgage specialist at Mortgage Logic, is among the experts who are warning that the chances of many loan holders triggering to default are now close.
The USA Housing Bubble Is Official — The Exuberance Index
The US Federal Reserve already gave the housing bubble stateside an official status, way back in March this year. This is no longer speculation and analysis. We are in a bubble, and as a direct result of both inflation and upcoming price correction in real estate, speeding toward another recession.
The Federal Reserve calculates a critical value (the red line in the graph) to gauge developing market bubbles early. Exuberance means not enough people are buying homes to warrant the price increases. This year’s prices are instead a result of years of interest and mortgage rate highs combined with extraordinary inflation.
The Federal Reserve tracks an Exuberance Index in the housing market every quarter, which indicates how out of touch are the current home prices with actual purchases. Five months of exuberance in a row indicates a bubble. This year, the bubble reached official status of 5 quarters plus exuberance in March. On the graph, the big crest is from the 2008 market crash era. This year’s trend is indicated by the later surge in the graph. Concerned economists are warning that the mortgage rates hiked even more since the official bubble status. By the time the Federal Reserve applies counter-measures, the bubble will hit its 9th month or later.
The situation is even worse in Canada, where they say a new bubble has formed atop a previously existing bubble. Canada hit its 26th straight quarter in the bubble in February this year.
Corporate Greed Feeding Into the Housing Bubble
In June 2022, Core Developments Group announced its intention to buy 1 billion worth of single-family homes to refurbish them as rental properties. They have chosen several middle-range cities in Ontario, especially areas with low vacancy rates.
ACORN, an anti-poverty group has rallied against this “frightening” plan. They protest the lack of rental control that keeps affordable shelter out of reach for middle- and low-income families and single-earners. ACORN blames high rents for the low vacancies, the reason Core Group cited for their intentions. Compared with 2019 rents in middle-sized cities of Ontario have climbed up by more than $1000. Single earners and families are finding it extremely hard to find places they can afford to rent while also having acceptable space and amenities for a peaceful life.
When Big Money jumps in real estate, it feeds into the market’s engine. All of a sudden, big chunks of residential plots and homes are out of the market at prices that family buyers cannot match. Next, renovation of the properties and management expense drives the rents too high. The market saturates towards exuberance, enlarging the housing bubble. Socio-economically, the rich usurp huge residential blocks for the affluent who can afford those rents on their way to home ownership. By attracting the affluent to the area, home prices in the area go even higher.
Billionaires Leaning Into the Housing Bubble
Jared A. Brock, an award-winning author, and a PBS documentarian has raised his voice against the trend of billionaires jumping into the real estate rental business in a September 2022 Medium post.
Since retiring as CEO of Amazon in 2021, Jeff Bezos has backed Arrived Homes which lets small investors buy shares in rental properties for $100. Here is how the company makes money, according to a description of its business model at MoneyMade:
1. They buy each home upfront, make home improvements, rent the home on a long-term lease, and then sell the home in the form of shares through their website. Arrived Homes makes money on transaction fees each time a home goes through this process. They can make a commission when they first buy the home (paid by the original seller) and can make money by creating additional home value through their home improvements and placing a long-term renter before they list the home on their website.
2. Arrived Homes also make some management fees for managing the portfolio of homes over time: A 1% management fee on the money people invest and then 8% of rent for property management.
Investors also make money when shares bring returns. Since these shares are in a rental property, the ‘revenue’ comes from high rent payments. The company itself earns profits through rent and its own shares.
The only way to increase “profits” in this system is to raise the rents periodically, especially following renovation or any other improvement. Corporate developers and foreign investors also generate their real estate millions the same way.
Jared Brock’s Criticisms Against Bleeding Real-Estate for Profits
Brock has no shame in calling such schemes as money hoarding by rent-trapping people in need of shelter.
When rents are expensive, hardly any money remains in the monthly budget of a single family to accumulate savings, enough to serve as a down payment to purchase a home down the road. Loan approvals are already beyond the dreams of many families. By turning affordable homes into rental properties, you have deprived a large portion of humanity of their own wealth opportunities. It goes into the toxic power struggling dynamic Allia Luzong talks about on this website.
Jared Brock frames Arrived Homes and similar corporate or billionaire interests in real estate as a massive problem for the future of humanity with these arguments:
- “For-profit land-lording … is a parasitical non-contributing activity that simply monopolizes property in order to loan it to someone and receive it back with interest rebranded as rent.”
- When businesses create returns they also create employment and products, and sell services. This contributes to the welfare of society through the distribution of wealth and by meeting various community needs. There is merit in scaling wages to skill and experience of employers and by scaling profits to a useful expansion of productivity. For-profit land-lording by-passes both merit and productivity and extorts its profits through rent control in its favor.
- Massive housing debt bubbles.
- The exuberance is not sustainable per any mathematical calculation, statistical model, or financial theory. It contributes to large-scale poverty which indeed we are witnessing in our times and countries.
Brock’s final argument comes from history and serves as the perfect conclusion for my piece today.
Every society that has given interest and profit hoarders free reins has, at long last, devolved into destruction through poverty and tyranny, rebellion, civil war and anarchy.
Let us be warned.
Even though I don’t understand real estate, I am also very afraid of this phenomenon. It caused many house prices to increase dramatically, making it very difficult for poor business people like me to buy a satisfactory house.