Should fear of a housing bust prevent people from buying homes?

Rather than react with excitement and increased urgency, potential homebuyers fear rapidly rising home prices signal a new housing bubble. Does it?

home_price_appreciation_fairyCalifornia endured three large housing bubbles since the early 1970s. Each one was kicked off by a huge house price rally, inflating prices well beyond any reasonable fundamental measure. From early 2012 to mid-2013, the house price rally was just as steep as previous price surges, but not as long in duration. Cautious home shoppers fear this latest rally may signal yet another housing bubble, but rather than purchase for fear of being priced out forever, buyers wait or decide to safely rent instead.

I consider this cautious behavior a great sign for housing. In the past, realtors could have scared buyers into action or appealed to their greed, but today those tactics fail more often than they work, partly because buyers are still wary after the recent bust, and partly because realtors have no credibility. Potential homebuyers react today with fear and trepidation when prices rise for no reason, as they should. Belief in the magic appreciation fairy is dead.

To determine if a housing bubble exists, potential homebuyers need a measure of value to base their decision on.

The most recent data is clear: we are not in a housing bubble — at least not yet. The long-term chart below has three important lines: median resale (purple), rental parity (green), and historic value (orange).

For the last three years, rental parity and historic value have been one on top of another, strongly implying a fairly valued market. Over the last nine months or so as mortgage rates continued dropping while rents continued rising, the market became undervalued by more than 10%.


Relative to rent, house prices are similar to the stable period from 1993 to 1999. And the new mortgage regulations will prevent future housing bubbles because the “Ability to Repay” rules will prevent reckless lending. That being said, it’s always wise to be cautious. If we do start inflating another housing bubble, it will show up in the data. Right now, the signs aren’t there.

Home shoppers today are right to be concerned about another housing bubble. It wouldn’t surprise me at all to see a reaction bubble form over the next few years as housing stimulus designed to bring up the non-performing markets overcooks our market. (See: Overcooking a recovery ripens a housing bubble) Perhaps the new mortgage regulations will prevent future housing bubbles, or perhaps not. It’s best to be cautious and prepared.