October 3, 2022

The housing market in the United States is a hot topic right now. I’ve seen videos showing lines of people waiting to get into an open house showing. Relatives of mine just went through the home-buying process and lost out on homes despite offering tens of thousands over the asking price.

It begs the obvious question: Is this a housing bubble, and if/when it will likely pop? It’s a tough question to answer because nobody knows for sure. However, you can look at the data and history of the housing market to get a sense of how things might play out in the months and years ahead.

Regulations are tighter this time around

I will admit that the housing market feels like a bubble right now, and perhaps it is a bubble. Housing prices are going up constantly, and it’s fair to wonder how much longer most families will remain in the market for a home. But there are some reasons why a “bubble burst” may not be as violent as you think.

Person pulling wooden bricks out from under a house model.

Image source: Getty Images.

The housing crash that began in 2007 is widely considered the most violent in U.S. history and is a reference point for many people watching housing prices skyrocket today. The 2007 crash is still debated to this day, and while I won’t try to pull apart all of the moving pieces, there are some important differences between then and what’s happening now.

First, there were systemic problems in the lending industry that “primed the pump” for what happened in 2007. Lending regulations were much looser then, and banks approved people for mortgages who couldn’t afford the payment. These mortgages were called “subprime,” and the percentage of subprime mortgages leapt from the mid-single digits in the early 2000s to 18% to 20% between 2004 and 2006.

Ultimately, many of these borrowers couldn’t pay their bills, and the resulting spike in foreclosures began a chain reaction that crushed housing.

The government tightened regulations following the financial crisis, and it’s now much harder to get a mortgage without having the appropriate income and credit score. That isn’t to say that speculation can’t pop up again, but the Dodd-Frank Act was created to prevent these bad lending practices from recurring. The takeaway? I don’t know that the housing market will “crash” without a shock to the banking system, like in 2007 when people began rapidly defaulting on their mortgages.

Supply versus demand

Historically, real estate has proven very resilient, with median home prices declining in just eight of the past 60 years. Consider the housing crash in 2007; you can see below that from the peak of prices leading up to the crash to a roughly 30% decline in prices at the market bottom.

Chart showing the 2007 crash in U.S. home prices and subsequent rebound.

U.S. Existing Home Average Sales Price data by YCharts

In other words, it took years for home prices to fall, and that was arguably the most violent crash in history!

Could recession cause prices to drop? Sure, and almost every year that median home prices did decline was during a recession. Mortgage rates are also rising, which makes financing homes more expensive, and could help cool demand from buyers. At 4.7%, rates are still near multi-decade lows, but they have risen quickly so far this year.

Ultimately, you need demand for housing to fall, in order for prices to fall. A recession or rising rates can have that effect, but nobody can know for sure when, or by how much. 

One of the unintended consequences of the housing crash in 2007 was that demand dropped so rapidly, that home builders basically shut down. The recovery of housing starts took years following the crisis, and today it’s estimated that America is short roughly 5 million single-family homes.

US Housing Starts Chart

US Housing Starts data by YCharts

Home prices will likely peak when supply and demand meet in harmony, which doesn’t seem to be the case yet. It’s hard to make that case until I stop coming across mobs of people trying to squeeze into an open house showing. When sellers no longer can turn away buyers offering thousands over the asking price.

There could be a recession coming, and mortgage rates might keep rising, like buckets of water trying to calm the raging fire of home prices in the U.S. Nobody knows for sure what will happen next, but I don’t see enough evidence that prices will be plunging anytime soon.