 It appears for now that Texans can relax. According to experts at Texas A&M’s real estate think tank – the Real Estate Center – Texans should stop worrying. There is no housing bubble in this here state.
Here in Texas, home price appreciation has not outpaced inflation. The values have risen but not at the unsustainable rate seen in some other parts of the country. Texas home prices have lagged behind the national average for some time. It is widely believed that the values will continue to climb, not fall. Other factors fending off the bubble talk in Texas include the population growth and economy’s outlook. The population in Texas is growing at a steady rate, increasing the demand for housing. The state’s economic forecast is good with moderate increases in hiring, continued hikes in corporate profits, and annual salaries on the rise. All of these are strong indicators that there is no bubble, and therefore no threat of a market collapse in Texas.
What is behind the record home sales?
The substantial growth of home sales and price appreciation has been propelled by consumer demand and low interest rates. Although real estate construction levels have held relatively constant for more than 30 years, the demand for new homes has jumped almost 75%.
Interest rates fell 1% between 2001 and mid-2003, reducing consumer monthly payments by 20%. For consumers with adjustable-rate mortgages, monthly payments have declined by as much as 35%. With consumer demand high and interest rates low, banks are using creative lending practices to meet market needs.
Risky lending options, such as interest-only, are increasing in popularity, fueling speculation of a bust if interest rates increase and home values decline.
What is a housing bubble?
Housing bubbles usually occur in high population density areas or where land use is restricted, such as California. But many communities are witnessing home prices dramatically outpacing inflation rates. This unsustainable increase is what experts call a “bubble.” In a bubble, the old adage holds true: What goes up, must come down. These high-flying prices have the potential to come crashing down to earth, dragging the economy with them.
If home prices plunge, individuals who bought at the peak of the market could get stuck in their homes with little opportunity to sell, unless they’re willing to take a substantial loss. Buyers who secured a risky, interest-only loan to purchase property would have no way of earning equity. People, particularly baby-boomers who cashed out their first home’s equity for a second-home investment or vacation home, could also find themselves in over their heads.
What could cause a bubble to burst?
There are two main factors that could force a housing bubble, if one exists, to burst: a steep rise in long-term interest rates or an economic downturn. If the Federal Reserve was to continue to raise interest rates, affordability would decline, softening consumer demand. Supply would likely increase as a direct result of consumers who opted for adjustable-rate mortgages and are now unable to make their monthly payment. The law of supply and demand tells us that a surplus of homes with little demand would not be good for homeowners.
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If the economy took a turn for the worse, leading to a drop in personal income and an increase in the unemployment rate, many people would likely default on existing mortgages or be unable to purchase a home altogether.
This is what a crash looks like
The impact of a housing crash on the U.S. economy has little to do with home sales slowing down and more to do with a reduction in consumer spending associated with homeownership. Consumer spending accounts for nearly 70% of our gross domestic product (GDP). High interest rates associated with a crash would take money out of people’s pockets, leaving less to put back into the economy. A crash would also mean that fewer people were moving, reducing the demand for appliances and home furnishings – again pulling money from the nation’s economy.
Additionally, dramatic increases in home equity have fueled consumer spending as people use their equity as income. Reduced equity would likely result in decreased spending. Finally, the Department of Labor says “construction is one of our nation's vital industries. It had a gross domestic product of over $480 billion last year and now employs more than 6.9 million workers.” A housing recession would have a dramatic impact on the housing construction and its related industries. It would also affect banks and real estate investors.
Not in Texas
Experts agree, the housing market is and will remain strong in Texas. However, there is one issue to note. Federal banking regulators are concerned about the undue risks associated with creative mortgage lending. Although a housing bust is unlikely, a mortgage bust may not be. In an attempt to curb a possible slew of mortgage defaults, the federal government is implementing guidelines as early as next year for mortgage lenders on limiting high-risk loans. The guidelines are only the first step. With the number of consumers participating in interest-only loans and adjustable-rate mortgages at an all-time high, it is likely the federal government will institute regulations restricting high-risk lending practices. This will undoubtedly slow the market, but it is not likely to force an industry crash, particularly in Texas.
So far it seems the bubble talk is just that – talk. But it’s impossible to predict where mortgage rates will go in the future. If you feel uncomfortable with all the bubble talk circulating in the media, you might consider avoiding loans that are deemed higher risk, opting instead for a traditional mortgage.
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