Home values have risen at staggering rates in the last year, and experts agree that this growth isn’t sustainable. Where there isn’t as much consensus around the results of an eventual market slowdown. Some believe the Las Vegas market is “bubble resistant,” while others think we’re headed toward a crash akin to the 2008 financial crisis.
Why the disparity? It’s easy to see why some think we’re headed for disaster. Many of the precursors are the same, and the market is exhibiting some bubble-like behavior. However, the underlying causes of this behavior are different—and that’s what we’ve broken down for you here.
Similarities to the ‘08 market crash
In the years and months leading up to the last massive market crash, conditions rose that we now understand to be signals of collapse.
Gas prices and international conflicts
Adults who lived through the 2008 recession know that the housing market crash was one part of a much larger financial crisis. It included a stock market crash, staggeringly high unemployment rates, and the worst overall economic recession the U.S. had experienced since the Great Depression.
Historically, spiking oil prices have preceded recessions. The 1973 recession occurred after the price of oil rose due to an oil embargo against the U.S. and other countries that supported Israel in the Arab-Israeli war. The 2008 recession was preceded by the U.S. invasion and occupation of the oil-producing nation of Iraq, which saw gas prices rising over $4 per gallon for the first time in history (over $5 adjusted for today’s inflation).
Now, Russia’s invasion of Ukraine has caused players in the market to reject Russian oil—which accounts for 13% of available oil overall. This in combination with oil refineries recovering from pandemic-era capacity cutbacks has caused gas to hit its highest price point since 2008. For some, this is a red flag that indicates trouble for the U.S. market.
Exuberance in home appreciation
Exuberance sounds like a fun word, but in finance and real estate, it has bleak indications. Exuberance is economic optimism that isn’t based on the real values of assets—or in this case, homes. Instead, it’s based on prediction alone due to previous appreciation. The idea is that since the value of the home was appreciating, it’s going to keep appreciating, and this optimism creates a positive feedback loop that results in explosive—but unsustainable—growth in value.
The problem with exuberance is that the prices of homes become detached from their underlying, real values. Prices rise uncontrollably until a correction occurs, either due to investors becoming cautious, policymakers intervening, or consumers no longer having the income to engage with the market. When that happens, the market either deflates or bursts.
The reason experts are sounding the alarm right now is that current appreciation rates echo the exuberance of the housing market leading up to the 2008 crash. In Las Vegas, home values have appreciated 33.6% in the last year alone, putting our city in the top 10% nationally.
The ratio of home prices to income is tied directly to housing affordability. When people can’t afford to purchase homes, inventory rises, and home prices drop. Right now, home prices in the U.S. are nearing the limit of what incomes can afford—and in Las Vegas, we’ve already surpassed that limit.
The general home price ratio rule is that a home should cost around 2.6 times your annual salary. The current average annual income here in Las Vegas is $65,907, while the average home value is $431,289. That means the average home in Las Vegas costs 6.5 times the average salary.
Adjustable-rate mortgage popularity
Mortgage rates also impact affordability, which is why the Federal Reserve will sometimes raise mortgage rates. This is done to deliberately cool the market by curbing uncontrolled and volatile growth.
A problem with this strategy is that some borrowers then turn to adjustable-rate mortgages. ARM loans start with a tempting, low interest rate. Later, those rates rise—sometimes pricing homeowners out of being able to afford their mortgage payments. This was a massive contributing factor to the 2008 market crash—and currently, ARM loans are again on the rise. Mid last month, Bloomberg wrote that adjustable-rate mortgages form the largest share of U.S. mortgages since 2008, up to 10.8% from 3.1% since the beginning of the year.
Today's market has key differences
Exuberance, unsustainable growth, a high home-price-to-income ratio; many signs point to an impending market crash. That’s why the Federal Reserve recently raised mortgage rates, and the cool-off has already begun in some real estate markets.
But while a market deflation seems imminent according to the signals, the results won’t look the same as they did during the Great Recession. Here are a couple reasons why.
Same indicators; different causes
The main reason to expect a market cool-off and not a market crash is that while market symptoms are similar to pre-2008 conditions, the root causes are not.
The current exuberance in the market isn’t being fueled by overborrowing. Instead, it’s being fueled by unexpected pandemic influences. Supply chain issues caused the cost of building materials to rise, while an increase in work-from-home availability drove many Americans to move to affordable cities and purchase homes, reducing inventory. These changes drove home prices fundamentally higher, which in turn caused a spike of homebuying FOMO from investors, who started snapping up properties. This has created a positive feedback loop of appreciation based on appreciation, or, exuberance.
This matters because in the years leading up to 2008, banks overlending to consumers to fund derivatives backed by mortgages caused the appreciation feedback loop—which means when the loop eventually broke, people owed more on their mortgages than their homes were worth. When the market crashed, those people defaulted on those mortgages, making the derivatives worth nothing, leading to massive financial collapse. Congress passed the Dodd-Frank Act to regulate the financial industry and prevent this from happening again.
Different mortgage rules
Anyone who purchased a home before and after 2008 knows that the requirements for obtaining a mortgage have changed drastically. Before 2008, anyone with a 720 credit score could get 80% funding up to $1M without income or asset documentation—and this was prime lending. These loans had the lowest interest rates and no prepayment penalties.
Subprime lending was even less stringent and included up to 100% financing without income or asset verification for people with credit scores as low as 620. These loans carried high, adjustable interest rates and high prepayment penalties.
After the 2008 crash, subprime lending ended, and applying for a standard mortgage became a lengthy, complex process with a ton of paperwork.
Borrowers must now provide detailed documentation of their income and assets, including tax returns, paystubs, profit-loss statements, and more depending on their personal situation. By design, it’s more difficult to obtain a mortgage now, which allows only low-risk individuals to borrow money and ideally prevents mortgage default.
This is important because it means that a cooling market won’t result in mass defaults on mortgages. People who have them are able to afford them, so market fluctuations are less likely to cause home losses.
So, is the market crashing?
While home values are predicted to keep rising into 2023, there are clear indicators of oncoming deflation. Looking at the signals, senior research economist Enrique Martinez-Garcia from the Federal Reserve Bank of Dallas says, “This might be a housing bubble.”
In Las Vegas, we’ve weathered housing bubbles before. We were one of the hardest-hit cities in the 2008 collapse. Home prices at that time dropped by 60%, which was twice the national average rate. Currently, homes in Las Vegas are estimated to be overvalued by 60%.
Signs point to a market slowdown, but don’t expect a frightening, 2008-style crash. Instead, expect home prices to rebound closer to their fundamental values and inventory to return to a more balanced level. Houses will likely spend more time on the market and buyers may have an easier time finding a better deal.
Not sure how to time the market?
We are. If you’re thinking about buying or selling but all this talk about a housing bubble has you stressed, reach out to a member of our team. We’ll be happy to analyze your unique situation, whether that’s helping you to understand what appreciation rates have done to your home’s value, guiding you through buying when you also need to sell, or just discussing your overall real estate goals. Together, we can create a plan of actionable next steps. Fill out the form below to start the process with our team.
Not ready to make any moves, but still looking to chat about the market? Give us a call at 702-710-7742 to learn from a local expert, today.