In the wake of our most recent housing bubble, many homeowners are weary of the direction the housing sector is currently trending. Home prices today are rising nearly as fast as they did during the peak bubble years of 2005-2006. Economists have begun to fret over the drastic upturn, as it bears a remarkable resemblance to that of the previous crisis. But an encouraging report issued by Trulia acknowledges that, while similar, the current housing market situation is unique and void of any potential bubble risk.
Even with the price of homes steadily increasing, as they did right before the housing bubble, home prices are undervalued on a national basis by approximately seven percent. Prices remain low, relative to fundamentals such as rent and income.
“Today’s price gains are actually still a rebound, not a bubble,” writes Jed Kolko, chief economist at Trulia.
To better understand the current market, it is important to distinguish the nature of a “bubble.” A housing bubble refers to situations in which prices increase beyond their fundamental value. A home’s fundamental value is directly correlated to supply, demand and realistic expectations. According to the theory of supply and demand, prices should move back toward an equilibrium determined by fundamentals.
However, bubble circumstances witness increased prices facilitate speculation and demand. Simultaneous increases in demand and price will ultimately lead to a burst, causing homeowners to panic and sell their property. Prices are then accelerated downwards, reverting to a level that was below their fundamental value.
Ambiguity, in association with a myriad of factors, makes a housing bubble nearly impossible to predict. However, Trulia’s recent evaluation of our current market suggests there is no reason to worry about an impending bubble.
As we enter the second quarter of 2013, national home prices are undervalued at approximately seven percent. By comparison, 2006 witnessed houses being overvalued by as much as 39 percent. Following the housing bubble, those same homes were undervalued by as much as 15 percent in certain markets.
Despite the recent upswing in current home prices, homes remain undervalued relative to fundamentals and significantly lower than they were in the last housing bubble. Current trends are more indicative of a rebound than a bubble.
If prices continue to increase at their current rate, the likelihood of an impending housing bubble would increase within several years. However, the following factors are likely to prevent prices from reaching that point anytime soon:
- Expanding Inventory: Restricted housing inventories are responsible for increased demand, causing buyers to bid up prices. However, increased prices will encourage more homeowners to sell, contributing to increased inventory and less competition.
- Expanding Mortgage Rates: Record-low mortgage rates continue to facilitate transactions. However, rates are likely to increase because of the recovery, slowing down price gains.
- Lower Investor Interest: As prices rise, investor interest will fade. Fewer investors will prevent prices from skyrocketing once again.