The Upcoming Housing Market Crash

One topic that has been getting quite a bit of attention recently is the state of the US housing market. A quick Google search, and you will find plenty of articles and commentary about how the housing market is overheated and we are in the midst of another housing market bubble, similar to what led up to the start of the Great Financial Crisis. The price of the average home in America crossed four hundred thousand dollars recently, up 20% in just 12 months. Prices continue to climb, and interest rates are skyrocketing, pushing the American dream of homeownership out of reach for many people.

These developments have many people saying that a crash is right around the corner. Even the Federal Reserve has come out saying that they are, quote, "finding signs of a brewing housing bubble." In this video, we are going to explore just what's going on with the US housing market, why so many people are worried, and the answer to the trillion-dollar question: are we really in a bubble?

I went through hours' worth of economic data and statistics when researching this video. All I ask for in exchange is for you to hit that like button. Seriously, that's all! And, okay, maybe subscribing to the channel if you aren't already. Now let's get into the video!

The total value of all single-family homes in the United States is estimated at a whopping 43.4 trillion dollars. At today's prices, that means based on his net worth of around 250 billion dollars, it would take roughly 174 Elon Musks to purchase all the homes in the United States. For most Americans, their home is the majority of their net worth. A significant portion of the US economy is tied to housing; in fact, housing roughly accounts for 15% to 18% of the United States economy.

That includes some big companies, like the major home builders, building material manufacturers, the banks that finance the homes, retailers like Home Depot and Lowe's, appliance manufacturers, all the way down to your local plumber and real estate agent, as well as the neighborhood hardware store. So many businesses and individuals rely on a healthy housing market in order to function.

Additionally, when home values increase significantly, individuals in the economy benefit from what is referred to as the wealth effect. This is a concept that as consumers' wealth increases, they are more likely to spend money. This means that if someone bought a home in Los Angeles, California, for 300 thousand dollars 10 years ago, and now the house is worth 1.3 million dollars, that one million dollars' worth of additional wealth makes them feel pretty good. Do you think they are more likely to go buy a new car or go on vacation than if they didn't have that extra 1 million dollars in net worth? That is the wealth effect in action.

I say all of this to get the point across: the health of the housing market is very much directly tied to the health of the broader economy here in the United States. Or put another way, if the housing market crashes, things aren't going to look too good for the overall economy or stock market. This is why the health of the housing market is closely monitored, and when cracks start to show, it can get people worried.

For the last few years, to say that anything tied to the housing market was doing well would be a significant understatement. Pretty much every company exposed to the US housing market has been making record profits. For example, D.R. Horton, the largest home building company in the United States, had 27.7 billion dollars in revenue and 4.2 billion dollars in profit in 2021. Just to put that in perspective, 10 years ago, in 2011, the company's revenue was 3.6 billion dollars, and its profit was 84 million dollars. This exemplifies how good the last decade has been for housing-related companies.

And businesses aren't the only ones who have benefited; the average homeowner might have been the biggest winner of the last decade. In the beginning of 2009, the median price of a house in the United States was two hundred eight thousand four hundred dollars. At the end of last year, that number has nearly doubled to four hundred eight thousand one hundred dollars. This means that the median homeowner has seen their home's value increase by 200,000 dollars.

This statistic is very well known, but I honestly think it masks just how much of a return on investment U.S. homeowners have been seeing in this housing market. In the U.S., the average down payment to purchase an owner-occupied single-family house is around 10% for a 30-year fixed-rate mortgage. This means that to purchase the median house back in the beginning of 2009, a prospective homeowner would have had to put down 10% of the 208,400 dollar price, which works out to twenty thousand eight hundred and forty dollars. This would have been their so-called equity in the house.

If you add on the additional nearly two hundred thousand dollars of appreciation since that time, that means their original equity of twenty thousand eight hundred and forty dollars has turned into roughly two hundred and twenty thousand dollars of equity. This doesn't even factor in any pay down of the loan they used to purchase their house. Based on the simple math, the median homeowner's equity here in the United States has increased by nearly a factor of 11 from the beginning of 2009 to the end of 2021, just purely on home appreciation. That works out to a compounded annual growth rate of around 20%.

This is an incredibly high return on any investment. For my day job, I work for a large investment fund. If there is a hedge fund manager or portfolio manager that could average an annual return of 20%, it wouldn't be too long until they are one of the richest people in the world because everyone will be begging that manager to manage their money. To put into perspective just how impressive that 20% annual return is, the long-term historical return on stocks is generally considered to be around 10%.

Home prices in the United States have been on a steady rise from the year 2010 to 2019, but over the last couple of years, prices for houses in America have skyrocketed. The median price of a home has increased by 20% just in the last year. There are certain hot real estate markets where prices have increased even more. From statistics I've seen, Austin, Texas is up 38%, Boise, Idaho is up 34%, and parts of Phoenix, Arizona are up 30%.

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Now, let's get back to the video. There are two big drivers of this rise in home prices in the United States. The first is that there simply aren't enough homes to go around. This is basic supply and demand. When there is more demand than there is available supply, prices can go up and, in some cases, substantially.

During the crash of the housing market in 2008, many home builders got burnt badly. And ever since, not enough new housing has been built to keep up with population growth. The U.S. Census found that 12.3 million American households were formed from January 2012 to June 2021, but just seven million new single-family homes were built during that time. That means during that time, the United States underbuilt new single-family homes by more than 5 million houses.

Single-family home construction has suffered from a severe labor shortage that began well before 2020, but was exacerbated by the events of the last two years. Supply chain disruptions in the past year have pushed prices for building materials higher. And as demand soared, prices for land increased as well. This has resulted in the fact that there simply aren't that many houses on the market available to be purchased. Prior to the last couple of years, there was consistently anywhere between 1 million and 1.5 million homes on the market; now that number is below 500,000.

This means that prospective buyers have fewer houses that they can bid on. So as the number of houses on the market able to be purchased decreases, while the number of people in the market looking to purchase a house increases, a rise in prices is a natural result. It's basic supply and demand. However, the shortage of houses is only part of the equation.

The other driving factor pushing housing prices high is interest rates. The overwhelming majority of people aren't rich enough to pay for a house in cash. In order to purchase a house, most people have to get a loan. In the United States, the standard structure is a 30-year fixed-rate mortgage, where the borrower pays a fixed amount for 30 years.

Interest rates have a huge impact on home affordability and ultimately the price of houses. I'm going to use an example to show what I mean. Let's say we have a couple named Jack and Jill, and they are looking to purchase a home. Based on Jack's and Jill's income, let's say they can afford a mortgage payment of 2,000 dollars a month before factoring in property taxes and insurance. When interest rates for a 30-year mortgage are 10%, Jack and Jill can afford to take out a loan of 228,000 dollars and still have a 2,000 dollar monthly mortgage payment.

But let's see what happens as interest rates decrease. If interest rates fall to 8%, that means Jack and Jill can now afford to take out a 273,000 dollar loan and not see their monthly payment change. If interest rates are 6%, they can now suddenly take out a 334,000 dollar loan. If interest rates fall even further to 4%, that loan amount continues to increase all the way to four hundred and nineteen thousand dollars. Notice how in this example, the size of the loan that Jack and Jill could take out increased from 228,000 dollars, all the way to 419,000 dollars, while still keeping that 2,000 dollar monthly mortgage payment.

The only variable that changed was the interest rate decreasing. Put simply, the lower interest rates are, the more people can afford to pay for a home while still maintaining the same monthly mortgage payment. Towards the end of 2018, interest rates on a 30-year mortgage were hovering around 5%, still low by historical standards. In January of 2021, that average interest rate had fallen to 2.5%. This may not seem like much at first glance, but it has a huge impact.

With a five percent interest rate, a prospective home buyer can take out a loan of 373,000 dollars and have a 2,000 dollar monthly mortgage payment. But when rates go down to 2.5%, that loan amount shoots up to five hundred and seven thousand dollars. That's an additional 134,000 dollars a person can borrow and still pay the same each month. People who wanted to buy a house could simply afford to make higher offers when interest rates were lower. To use an analogy, the housing market was already on fire due to the low supply from years of underbuilding; adding these low interest rates into the mix was like pouring fuel on the fire.

However, it's important to understand that this phenomenon I just described can work in reverse. As interest rates rise, home buyers have to pay more each month in order to afford the same size loan. This dynamic is currently at play in the market, and this is one of the biggest factors many people are pointing to as to why the housing market is on shaky territory. Interest rates on a 30-year mortgage are increasing at the fastest rate since 1994. At the beginning of this year, the average interest rate on a 30-year mortgage was around 3%. In the matter of just a few months, that interest rate has shot up to 5%. This is the highest mortgage rates have been in 10 years; the last time 30-year mortgage rates were this high was back in 2011.

Honestly, it seems like interest rates are going to get even higher. Mortgage rates are priced based on what is called the 10-year treasury, which is essentially the interest rate at which the US government can borrow money for 10 years. Yields on the 10-year treasury are currently at around 3%, that's up almost three times what they were less than a year ago. As yields on the 10-year treasury increase, mortgage rates are bound to follow. Odds are, these interest rates are going to get even higher; in order to combat the worst inflation in decades, the Fed has already signaled to the market and the economy that they are going to raise interest rates.

What has been amazing and surprising to people is that even though interest rates on mortgages are close to doubling from where they were last year, it hasn't had a huge effect on prices yet. Houses are still getting multiple offers within days of listings, and bidding wars are still common. This is making a lot of people nervous. The median household pre-tax income in America is around seventy thousand dollars. If we assume a twenty-five percent tax rate, this means that the median household in America makes around fifty-two thousand dollars a year after taxes.

That works out to four thousand three hundred and seventy-five dollars a month. When interest rates were at two point eight percent, that works out to a mortgage payment of one thousand two hundred and ninety-four dollars before property taxes and insurance with the 10% down payment on a 350,000 dollar house. That means that around 30% of the household's after-tax income each month was going towards the mortgage payment. Not bad; this left 70% of the income for other household expenses and savings. With interest rates now at 5.5%, that mortgage payment is now 1,788 dollars, and that now means that 41% of the household's income is going to the mortgage even before factoring in property taxes and homeowners insurance.

If interest rates jump to 8%, that mortgage payment is now two thousand three hundred and eleven dollars, a whopping fifty-three percent of the household's after-tax income. This leaves less and less money that the households can use towards other expenses or to save and invest. Two things are happening here: homeownership is getting further out of reach for the typical American family as household incomes have not grown fast enough to keep up with the cost to buy a home. But the other thing that is happening is that it is making the housing market less stable. People that are most likely to not be able to pay back their mortgage and risk losing their house to foreclosure are people for whom the mortgage payment makes up a larger portion of their income.

So while the economy is still very strong as of now, if there was a slowdown or even a recession in the economy, the people that have 40% to 50% of their after-tax income going to their mortgage payment are likely to be the first to default on their mortgages. The more households there are with a larger mortgage payment relative to their income, the more potential foreclosures could happen. While the housing market seems strong for now, I definitely do see some, let's just call them warning signals on the horizon. If interest rates increase, I think it naturally has to have some dampening effect on home price appreciation. If we see a significant slowing in the economy, it could lead to default and foreclosures on people who stretch their budget to buy a house in this crazy housing market. This could lead to downward pressure on prices.

However, with that being said, I don't see prices coming down significantly unless something drastically changes. So there you have it. Make sure to like this video and subscribe to the Investor Center if you aren't already because it is my goal to make you understand the investing landscape. You guys are great! Looking forward to speaking to you again soon.