What should investors worry about?
It’s the topic people love to discuss. Are homes overpriced? When will “they” stop building new homes? Are we in the middle of another housing bubble? What should we do?
Across the country, at backyard barbecues, sporting events and in restaurants, the conversation goes something like this:
“The Johnsons paid how much for their new house? That’s crazy. They way overpaid. How can they afford that? They both have good jobs, but they’re not doing that well, are they?”
“the Smiths are selling their house for how much? They just bought that house six years ago and no one will pay what they’re asking. I’ve been in it, it’s kind of dated too.”
Let’s examine the current housing market.
Definition of economic bubble: A market phenomenon characterized by surges in asset prices to levels significantly above the fundamental value of that asset.
From the National Association of Realtors:
From these facts, it’s easy to conclude that housing is doing pretty well. But is it a bubble? That’s harder to answer, especially since the realtor’s mantra of “Location, Location, Location” applies to this question as well. The facts are that home price increases are faster in Denver, slower in Des Moines, faster in San Francisco and slower in Omaha. So, it depends on where you live.
So, let’s examine another trend: relative affordability.
We’ve established that home prices are rising dramatically. In fact, home prices are up a whopping 34% from 2012. So, it stands to reason that the increase must be in part driven by an increase in family incomes, right? Not so fast.
Take a look at this chart from mybudget360.com:
Here is what the chart tells us: from 2003 to 2007 housing prices and incomes went up together (recognizing that home prices were already on a consistent trajectory upward). Remember what happened in 2007? If not, let me remind you.
Housing prices peaked in 2006 and started to decline the following year, reaching lows in 2012. And as the Housing Crisis was in full force, not only did housing prices drop, but so did family incomes, which makes sense.
Then in 2012, home prices started to improve and so did family incomes. Again, makes sense. But that increase in family incomes didn’t last long. Yet the increase in home values continued unabated. I’ll say it again: since 2012, housing prices are up a whopping 34%. And family incomes are almost flat. Think that’s a problem?
Let’s reduce the conversation to simple statements:
Conclusion: we’re in a housing bubble – in some markets.
That’s the million-dollar question. No matter which side you agree with more, the reality is that individually we can’t really reverse whatever the outcome might be. That being said, as a financial advisor, I do have some thoughts about the housing market.
First, for the vast majority of my clients, their house is their largest asset and investment, so they need to make a good decision.
And there is no blanket statement that I can make that covers every scenario. Sometimes, that young couple might be better off stretching themselves into a house they can barely afford, knowing that their salaries are increasing.
And sometimes, that older couple with high-school students should think about downsizing now, rather than wait until they must downsize, when conditions might not be favorable.
Second, I always counsel my clients to thoroughly examine their finances when they tell me they’re buying a house. And I ask them the tough questions: what happens if one of you loses your job? Gets sick? Gets transferred to another city? Has a child move back in?
Third, make sure you talk to an experienced realtor. Not your sister’s friend who dabbles in real estate – someone who has been a realtor in your local market for a long time and has seen the ups and downs of your local market. A good realtor will tell you when you’re overpaying, will tell you where you should price your house and provide invaluable information during the process, thereby saving you money and heartache.
Finally, I’ll say it again: remember that your house is likely going to be your biggest investment and asset. You should absolutely account for it in your financial plan. Call me and we can discuss how.