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Financial Industry Insights from Advisors Asset Management
On May 01, 2017
AAM Viewpoints – 2-Part Series | Part 1: Are We Facing Another Housing Bubble?
Traditionally, the housing market is not as prone to bubbles as other financial markets, but we are seeing more and more headlines speculating that we may be on the verge of the next correction in the housing market. The last housing bubble began forming after the 2000 stock market crash as home ownership began growing at an alarming pace while interest rates were dropping and the government encouraged banks to reduce lending requirements. This buying frenzy drove prices up by 50 to 100% in some regions. During 2005 – 2007 prices peaked as the stock market began to rebound and interest rates began to move up. Housing prices then began to plummet, which was evidenced by a decline in housing prices by more than 40% in some regions and in 2008 the Case-Shiller home price index reported its largest price drop in the history of the index. Factors such as high growth in home ownership, low interest rates, and relaxed lending requirements all contributed to the bubble bursting. Unemployment began rising in 2007 and led to a perfect storm in which many homeowners could no longer afford to pay their mortgages. In October 2007, the U.S. Secretary of the Treasury called a bursting housing bubble the most significant risk to the broader economy and a year later the housing market collapse sparked the worst financial crisis since The Great Depression.
Coming out of The Great Recession, home prices began to rise and foreclosures began to fall as the economy recovered. The recovery led to several positive trends in housing, including improving existing home sales, higher home prices and an increase in single-family housing starts. The strength in the housing market is also important when evaluating the direction of the economy. The National Association of Home Builders (NAHB) research shows that building 100 single-family homes in a typical metro area creates 297 full-time jobs and generates $28 million in wage and business income and $11.1 million in federal, state and local tax revenue. The industry continues to add jobs, with monthly employment data for February showing that home builder and remodeler employment increased by 18,900. Over the last 12 months, it’s estimated that home builders and remodelers have added 136,000 jobs on a net basis and residential construction employment now stands at 2.707 million.
Rising home prices can also lead to higher consumer spending and contribute to economic growth. The relationship between housing and gross domestic product (GDP) is reflected in the cycles of residential fixed investment (RFI), personal consumption expenditure and GDP growth. Quarterly data from the U.S. Commerce Department provides insight into the contribution that residential construction has on the U.S. economy and estimates of fourth quarter 2016 GDP growth show that housing's share of GDP stood near 15%.
As economic and employment outlooks improved, consumer confidence moved up and the trends in real estate have been positive. The chart below illustrates the positive correlation between the National Association of Home Builders/Wells Fargo Housing Market Index (HMI) and Consumer Confidence. Prices nationally are up over 5% in February year over year with Washington, Oregon and Colorado seeing the biggest price gains.
Source: Advisor Perspectives
HMI measures U.S. builders’ confidence and a reading above 50 indicates builders view conditions as good. The survey reached 71 in March which is the highest level since June 2005. All three HMI components (current single-family home sales, sales expectations for the next six months and traffic of prospective buyers) posted gains in March.
Existing home sales were up 4.4% for the month of March. Sales have now increased to a seasonally adjusted annual rate of 5.71 million units according to the National Association of Realtors (NAR). This is the highest since February 2007. While the number of homes on the market rose 5.8% to 1.83 million units last month, housing inventory was down 6.6% from one year ago, implying that demand is outweighing supply.
Source: National Association of Home Builders
Builder sentiment and total housing starts also reflect housing market strength. Although housing starts declined in March, we witnessed a strong pace in February. Single-family starts posted a monthly decline of 6% in March, falling to an 821,000 annual rate. The February annualized rate, 875,000, was the fastest monthly pace since The Great Recession, while the rate in March ranked fourth. The three-month moving average of single-family starts reached a post-recession high in March and the NAHB is forecasting continued growth for this sector as the year progresses.
Housing bubbles may occur in local or global real estate markets. When they enter their late stages they are typically characterized by rapid increases in valuations and other factors such as affordability. The positive trends in the market have some observers calling for the next correction in the housing market.
I would suggest these trends are indicating a healthy market that is not due for a correction. A key contributor to the real estate bubble bursting in 2006 was the loose lending standards. In Part 2, which will be out in a few weeks, we will focus on housing affordability, home prices, and inventories. One thing is for sure, we are seeing strength in several regions across the country so these data points will be important in determining the future direction of this market.
CRN: 2017-0501-5942 R
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.
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