Brought to you by Scott P. Rogers, Funkhouser Real Estate Group, 540-578-0102, scott@HarrisonburgHousingToday.com
Brought to you by Scott P. Rogers, Funkhouser Real Estate Group, 540-578-0102, scott@HarrisonburgHousingToday.com
Monday, April 12, 2021
One of my colleagues has asked me several times in recent months if it seems like our local real estate market is getting frothy.
I have said yes, but without a full understanding of what exactly is typically meant by "frothy" when referring to a real estate market.
Let's take a look, based on some great information from investopedia.com.
What Is Froth?
"Froth refers to market conditions preceding an actual market bubble, where asset prices become detached from their underlying intrinsic values as demand for those assets drives their prices to unsustainable levels. A frothy market is one where investors begin to ignore market fundamentals and bid up an asset's price beyond what the asset is objectively worth. Froth in the marketplace is often characterized by overconfident investors and is a sign that investor behavior and investment decisions are being driven by emotions."
"Froth refers to market conditions preceding an actual market bubble, where asset prices become detached from their underlying intrinsic values as demand for those assets drives their prices to unsustainable levels. A frothy market is one where investors begin to ignore market fundamentals and bid up an asset's price beyond what the asset is objectively worth. Froth in the marketplace is often characterized by overconfident investors and is a sign that investor behavior and investment decisions are being driven by emotions."
Picking that apart a bit...
- If the market is frothy does that mean a market bubble is on the way? Maybe, maybe not. Read on for more on that.
- Is demand for homes driving their prices up to unsustainable levels? Demand is certainly driving up prices -- but it's not yet clear if they are getting to unsustainable levels. Low interest rates have kept payments quite affordable for buyers, which has not made higher prices unsustainable -- and it is still more affordable for many/most to buy (even at this prices) as compared to renting. As such, despite rising prices, there is not yet an indication that these are unsustainable higher prices.
- Are houses being sold beyond what they are worth? It feels that way sometimes to some buyers -- but a house provides great utility -- you need somewhere to live, so there is still a great worth of houses to buyers.
- There are several references to investors in the definition above -- which we could take literally as investors, or figuratively as buyers. There is certainly some amount of investor activity in the local market but not necessarily an extreme amount of investor activity. If it were mostly investors buying houses, I would be more concerned about a turn in the market.
- Are decisions being driven by emotions? Ha. Perhaps all house buying decisions are always driven by emotions, regardless of the market? :-)
What Might Happen?
"A frothy market can be the precursor to a market bubble, which may lead to a severe contraction of asset prices, also known as a crash or burst bubble. The dotcom boom and bust of 2001 and the housing crash of 2007-08 are examples of asset frothiness that eventually lead to burst bubbles. Both bubbles were marked by increased levels of investor speculation that continued until investor confidence waned and sell-offs ensued, leading to a market correction and a sharp decline in prices."
I suppose the best way to think about now (2020-21) as compared to the housing crash of 2007-08 is to consider investor participation in each of those timeframes. We did see a high number of investors buying homes in 2007-08 which was temporarily driving up demand, and thus prices, and then everything came tumbling back down. While it's difficult to precisely measure, I don't think that the level of investor participation in the market is as high now as it was then. Most competition for new listings seems to be from owner occupant buyers as they are generally willing to pay more than an investor for most property types and price ranges.
How to Spot Froth in Real Estate Markets
Here are some of the ways to spot froth in a real estate market per investopedia...
- Sketchy Loans Are Common - this doesn't currently seem to be the case
- There's Lots of Leverage at Work - also not necessarily currently true
- Salaries Aren't Keeping Pace With Home Prices - also not currently true but perhaps at least partially because of low interest rates.
- Interest Rates Rise - we don't know yet what will happen if/when interest rates rise. Will market activity slow? Will prices flatten out or decline?
The whole article over at investopedia.com is worth a read.
Does our current real estate market seem frothy? Yes.
Will it result in a real estate downturn? Maybe, but not necessarily.
Should we be worried? Maybe, but not necessarily.
