New homes under construction in Las Vegas, where housing prices dove sharply during the foreclosure crisis.
New homes under construction in Las Vegas, where housing prices dove sharply during the foreclosure crisis. Steve Marcus/Reuters

In cities nationwide, home prices are at or above their pre-recession levels. But it’s no bubble.

Housing prices are cooking. Across the nation, the price of homes is rising faster than the rate of inflation—in some places by a factor of three. That’s true of high-cost cities such as Seattle and San Francisco and lower-cost cities such as Charlotte and Tampa alike. And the overheated market for homes is costing the middle class the American dream.

Nationwide, the price for homes is approaching the zenith seen in 2006, just before the market fell into a foreclosure crisis and the economy sank into the Great Recession. No major city appears to be spared from these rising temperatures. New highs or near highs in Los Angeles and Washington, D.C., are mirrored by similar (relative) highs for Cleveland and Chicago.

But there are key differences between the housing peak in 2006 and the housing peak today. This surge in housing prices is not necessarily evidence for a bubble—much less any indication that a bubble is about to burst. Understanding the difference is critical to knowing how high housing costs may affect the economy going forward.

Late in July, the S&P CoreLogic Case–Shiller U.S. National Home Price NSA Index tracked a 6.4 percent annual gain in home prices for May 2018. This index has recorded year-over-year increases of at least 5 percent every month since August 2016—a sign of the strength of the recovery. Len Kiefer, deputy chief economist for Freddie Mac, shared a visualization for these data; in Seattle, which saw a year-over-year price increase of 13.6 percent for May, home prices are already well above the 2006 high-water mark.

But since most workers aren’t earning 6 percent raises year after year, eventually this party has to come to an end. (Indeed, for four-fifths of privately employed workers, wages are actually falling.) Housing prices will stabilize or soften because they have nowhere else to go. The prevailing trend is unsustainable. “If something can’t go on forever, sooner or later it will end,” says David Blitzer, managing director for S&P Dow Jones Indices. With mortgage rates and prices rising, sales in both new homes and existing homes are starting to slow. “Either buyers have gone for the summer, because it’s too hot to look at housing, or they’re pausing to see what’s going on,” Blitzer says. “If the pause continues, you’ll see sales go down.”

A slowdown could be a good thing for some households that are looking to buy homes—“a small plus for consumer sentiment,” according to Blitzer. A pause might indicate that people feel less rushed to buy, meaning that when they do buy, they feel comfortable about the decision that they’re making. “The flip side of that [is] the sellers won’t be making out like the bandits they thought they would be six months ago,” he says. But there’s no reason to believe that, if and when a downturn arrives, it will spiral into a collapse.

One big difference is in the relative dearth of banditry today. Speculators aren’t driving new home construction during the recovery the way that they did during the boom. Researchers from Chinese University of Hong Kong, Princeton University, and the University of Texas at Austin have shown (in an as-yet-unpublished paper) the economic consequences of betting on the housing market: Cities with a higher share of investment homes saw higher highs (and lower lows).

The harrowing experience of Las Vegas during the foreclosure crisis a decade ago illustrates the role that speculation played. Between 2000 and 2005, the share of non-owner-occupied home purchases in Las Vegas rose from about 18 percent to above 29 percent. Three years later, that level was back down to 18 percent—but the damage was done. Las Vegas witnessed a huge spike in housing values during the boom (more than 120 percent) followed by a nosedive (more than 50 percent).

New York, on the other hand, suffered less during the foreclosure crisis. The researchers show that the share of non-owner-occupied home purchases never edged north of 7 percent in New York. The city’s housing prices appreciated 80 percent during the boom before falling 25 percent over the bust—a lower high and a higher low.

High housing prices today aren’t the result of exuberant buyers and builders feeding off one another. Nobody’s building anything. As the chart below shows, housing starts have picked up since the Great Recession, but new residential construction has yet to meet the level before the boom. Housing starts at this point in the recovery aren’t even what they were during the early 2000s recession. There’s no surge in construction to meet (and fuel) demand from investors. Prices have rebounded over the recovery; construction hasn’t.

Federal Reserve Bank of St. Louis

With fewer opportunities, American homebuyers face fierce competition—those who haven’t been left behind by the housing market, anyway. At the high end of the spectrum, wealthy buyers from abroad have escalated the chase for homes in affluent neighborhoods with all-cash bids, often above asking price. While foreign purchases represent only a small share of the market overall, they’ve left a mark on cities such as Seattle and D.C.—although they appear to be leveling off now.

A different phenomenon confronts the lower end of the market. All the speculative construction in places that bet big on the boom—followed by a wipeout wave of foreclosures—has led to a supply overhang in places, meaning not enough qualified buyers for homes. Corporate landlords have scooped up some of this inventory, converting formerly owner-occupied houses into single-family rentals. As with foreign purchases, it’s only a tiny share of the overall market, but in certain cities (especially in South and West), the effect is pronounced.

If the housing market were an investment bubble set to pop any day now, we might expect more construction and more buying along with the higher housing prices—think Las Vegas or Phoenix or Tampa during the boom. Instead, more cities share the experience of New York, where even a speculative craze did not drum up that much new construction. There’s interest from investors at both the high and low ends, but there just isn’t the make-a-buck building boom to merit a bubble. This time, soaring prices may reflect something more banal: low inventory and high demand, with frustration all around.

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