Luke Davis: Are we in another housing bubble?
It’s amazing how quickly things can change. A little more than five years ago my wife and I were struggling to sell our home in a housing market that was in dire straits.
At one point during the year-long process, more than half of the homes in our cul-de-sac had for sale signs in the yard. As we continued to slash our asking price I began to believe the growing sentiment that the era of home ownership was over because they were no longer a good investment.
Fast forward to today, and the housing market couldn’t be more red-hot. According to the Kansas City Regional Association of Realtors, in August the average sales price for a home in the KC metro was $267,000 and sold in less than a month at 99.2% of asking price.
I went back and compared this to when we were selling our home in early 2015 and was amazed by the difference. At that time the average sales price was about $166,000, homes typically stayed on the market for more than three months and sellers were lucky to get 90% of asking price. We are not alone in this housing boom.
With unemployment rates hovering around 10%, I have been a bit confounded by how little the housing market has been impacted by COVID-19. If anything, the rate cuts that have followed this pandemic, paired with stimulus checks being sent to individuals, have increased demand for homes and driven prices even higher.
For those at or near retirement looking to downsize or rent, I believe this is absolutely the best time to sell. However, for those in the market to buy, you face a mixed bag of factors that need to be considered before signing on the dotted line. While it’s true that interest rates are at historically low levels, prices are near record highs. These low rates tempt many buyers into spending more on a home than they should because the payments remain manageable even when paying more.
In this extreme low interest environment I’m not sure if the standard rules for how much home you can afford apply. Generally, the rule of thumb I have supported is to put down at least a 10% and to keep the monthly mortgage payment at 25% of one’s monthly income. However, in today’s environment a family with a $100,000 income locking in at a 2.5% rate is able to buy a home for roughly $250,000 using this formula. With housing prices substantially inflated I would advise against this high of debt-to-income ratio.
Here’s why this scenario scares me. If an economic recession causes housing prices to drop, and at the same time homeowners become unable to continue making their payments, things could turn south very quickly. Hypothetically, we could find ourselves in another situation where people who are drastically underwater on their houses become foreclosed on because they can no longer afford or sell their homes. This could leave banks once again holding notes for substantially more than the underlying asset is worth creating yet another financial crisis.
Does this sound anything like the debt bomb of 2008 to you? It does to me. I’m not claiming this scenario will play out, or that it’s even likely. But what I will say is you need to be very careful if buying a home right now. Spending more on a home than you should is never a good idea, but right now the danger is higher than at any time since the mid-2000s.
In a market where many homes are being sold the same day they are put up for sale, it can be easy to get wrapped up in this buying frenzy and do something stupid. Don’t. Debt is dangerous and taking too much “free” money could cost you far more than you expect.
(Past performance is no guarantee of future results. Advice is general in nature and not intended for specific situations)
Luke Davis is the director of operations and compliance at Stewardship Capital in Independence.