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Some cities might be in a housing bubble

November 2, 2017

A lot of people, including lenders, are still affraid of unreal house prices increase. In order to determine whether some market is in housing bubble, we need to know the reason for the price growth. Rational reasons could be increase in household income.

Housing in the U.S. remains very much in the affordable range. In fact, the median household can afford a house that is $70,000 more expensive than the median home price today. In 2006, the median household could only afford a mortgage that was $22,000 more expensive than the median home price.

Of course, real estate is local, so we should also ask if there are any regional housing bubbles. Six metros stood out above the rest: the San Francisco area and the San Jose area tied for the top ranking in the institute’s bubble watch. The Miami area and Oakland, California areas tied for third place, and the Portland and Seattle areas tied for fifth place. 

When explaining regional bubbles, take the following factors into account:

  1. Lack of building has constrained supply. Most of the 25 metros that rank highest on the measure have experienced shortages of housing supply in recent years. The only exceptions are Detroit, Michigan, and Forth Worth–Arlington, Texas.

  2. Some markets are rebounding from “overshooting” in the downturn. As the poster child for declining cities, Detroit didn’t experience much of a boom during the last bubble but saw a major bust as the bubble burst. Detroit house prices increased only 12 percent at the height of the housing bubble but dropped 62 percent in the downturn. Despite the rapid home price increase from the trough (ranked 3rd), Detroit remains one of the most affordable areas (ranked 23rd). Detroit has the biggest gap between the two measures. Its number 14 bubble-watch rank is mostly driven by home price growth, different from similarly ranked Phoenix, which has seen relatively rapid house price increases and limited affordability.

  3. International investors are buying houses in certain areas. International activity in the US residential market has been strong in recent years, and California, Florida, and Texas are the top destinations for foreign buyers. Metropolitan statistical areas in these states rank high in our bubble-watch list.

  4. New nontraditional investors are buying houses to rent. This may increase purchase prices and rental prices in ways that are unsustainable.

This bubble-watch measure is a signal to pay attention to whether house prices in these markets have become unsustainable. This is an important consideration for public policy and affects several issues, including whether the Federal Reserve should continue to increase interest rates and whether states and localities should rethink building and land-use restrictions.

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