In the last two years, the real estate market has dominated headlines across the U.S. News about ultra-low interest rates, spiking home values, and extremely low inventory have been all over the news.
In Bethesda, buyers have even been told to sit the market out until it cools because competition is so fierce. Now that mortgage rates have risen and the housing market is showing signs of cooling, everyone wants to know the same thing: is the market going to crash like it did in 2008? It’s a fair question since our current market shares several markers with the one that led to the Great Recession.
Fortunately, some key differences indicate we’re headed for a market correction rather than a disaster. Let’s break down both.
Similarities to the ‘08 market crash
In the period before the 2008 real estate crash, conditions arose that we now understand to be signals of collapse. Market watchdogs now sound the alarm when similar conditions arise—and some of them are sounding that alarm right now.
Gas prices and international conflicts
Anyone who lived through the 2008 recession knows that the real estate market crash was one piece of a much larger economic puzzle. It included a stock market meltdown, extreme unemployment rates, and the worst overall recession the U.S. had experienced since the Great Depression.
Why does this matter? Because to understand the housing market, we must understand that fluctuations within it don’t happen in a vacuum. It’s affected by other parts of the U.S. and global economies as well as events that, at face value, don’t seem to relate to real estate and finance.
For example, there is a clear pattern of international conflicts and spiking oil prices preceding recessions—and housing market dips.
The U.S. experienced the 1973 recession after oil prices shot up due to an oil embargo against the U.S. and other countries that supported Israel in the Arab-Israeli war.
The 2008 recession happened after the U.S. invaded and occupied the oil-producing nation of Iraq, resulting in gas hitting prices over $4 per gallon for the first time in history (over $5 adjusted for today’s inflation).
Now, players in the global market are rejecting Russian oil—which accounts for 13% of available oil overall—due to the country’s invasion of Ukraine. This, in combination with oil refineries still recovering from pandemic-era lowered capacities, has caused gas to hit its highest price point since 2008. For some, this is a red flag signaling trouble for the U.S. economy and thus the housing market.
We’ve seen intense demand and limited supply for several years in Bethesda’s housing market, which has driven home values up. This is great for homeowners, until home prices outpace incomes to the point of unaffordability. Why? Because when people can’t afford to purchase homes on their salaries, inventory rises, houses sit on the market for extended periods, and home values drop sharply—and no homeowner wants that.
Right now, home prices in the U.S. are nearing the limit of what incomes can afford, just like they did in the early 2000s. In Bethesda, we’re already far past that limit.
The general home price to income ratio rule is that a home should cost around 2.6 times your annual salary. The current average annual income here in Bethesda is $74,420, while the average home value is $1,188,606. That means the average home in Bethesda costs 16 times the average salary.
Adjustable-rate mortgage popularity
Mortgage rates also impact affordability, which is why the Federal Reserve will sometimes raise the federal funds rate. The federal funds rate is a benchmark interest rate, and when it increases, it becomes more expensive for banks to borrow money from other banks. The consumer then feels that by way of rising mortgage rates.
Why on Earth would the Fed want to drive up mortgage rates? Usually, it’s to prevent a real estate market crash. When mortgage rates rise, demand typically falls in a controlled way, curbing the type of explosive growth in the market that causes real estate bubbles.
A problem with this market-cooling strategy is that it causes some borrowers to turn to adjustable-rate mortgages. ARM loans start with a tempting, low interest rate. Later, those rates rise based on the market—sometimes pricing homeowners out of being able to afford their mortgage. This was a huge contributing factor to the 2008 market crash—and currently, ARM loans are on the rise. Bloomberg recently 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.
Exuberance in home appreciation
Exuberance is a financial term that isn’t as fun as it sounds. It’s characterized as economic optimism based on prediction instead of the real value of assets. The idea is that since the value of the asset, or home, was appreciating, it’s going to keep appreciating, and that 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 across the country echo the exuberance of the housing market leading up to the 2008 crash.
Bethesda’s modern market has key differences
In some ways, Bethesda’s market is insulated from these red flag indicators. Our market hasn’t experienced the wild appreciation of some other markets in the last year or two. Home values here are high, but they’ve been steadily rising at a lower rate for many years. In the last year, they’ve risen 9.1%. By comparison, similarly-sized suburbs of other major U.S. cities have risen dramatically.
Comparatively, Bethesda’s appreciation rate is in line more with traditional rates and less with exuberant growth.
While a market correction does seem imminent based on the signals and has already begun in most markets, the results won’t be catastrophic like they were in 2008. Here are a few reasons why.
Different mortgage rules
If you’ve purchased a home before and after 2008, you know that the requirements for obtaining a mortgage have changed—a lot. Before 2008, anyone with a 720 credit score could get 80% funding up to $1M without income or asset documentation. This was known as prime lending, which had the lowest interest rates and no prepayment penalties.
Subprime lending was even less stringent. It allowed up to 100% financing without income or asset verification for people with credit scores as low as 620. The catch? 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. 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 can afford them, so market fluctuations are less likely to cause home losses.
Same market indicators; different causes
This overlending of subprime loans is what caused the exuberance in home value appreciation leading up to the 2008 crash. Banks did this to fund derivatives backed by mortgages. The intent wasn’t to cause more demand in the market, but since more buyers had funding, demand rose sharply, which in turn drove values up. The problem occurred when the exuberance feedback loop broke and homeowners owed more on their homes than they were worth. And for many with subprime ARM loans, mortgage payments became impossibly expensive when interest rates rose.
When those homeowners defaulted on those mortgages, the mortgage-backed derivatives lost all their value, leading to massive financial collapse. A main reason to worry less about a repeat of this history with the current market is that this type of lending no longer exists. Congress passed the Dodd-Frank Act to regulate the financial industry and prevent this from happening again.
So, what caused the home value spike this time?
The current exuberance in the U.S. market wasn’t fueled by overlending. It was instead the result of pandemic-related influences. Supply chain issues caused the cost of building materials to rise, and an increase in work-from-home availability allowed many Americans to move to affordable locations and purchase homes. This coupled with record-low mortgage rates increased demand and reduced available inventory, raising values.
This in turn caused a spike in homebuying from investors afraid of missing out. That created a positive feedback loop of appreciation based on appreciation, or, exuberance.
The important part to understand is that since the value growth was initially caused by organic demand from financially qualified buyers, the result of a market correction won’t be mass home loss or financial collapse. Instead, it’ll look more like a rebalance of a market that’s been skewed for quite some time.
So, is the market crashing?
The short answer is: no. Bethesda’s housing market has been stable over the last several years compared to other places in the country. Home values have risen, but not as dramatically as they have in the rest of the U.S. Instead of a disaster, expect home prices to rebound closer to their real values and inventory to return to a more balanced level.
Prospective buyers can breathe a little easier knowing that cool-off is already happening—partially thanks to rising mortgage rates. In the last month alone, inventory in Bethesda has risen 83%, and houses are spending about 20% longer on the market. This indicates that on the current trajectory, buyers will have more options, more negotiating power, and an easier time finding a deal.
Not sure how to time the market?
We are. If you’re thinking about buying or selling but all this information about mortgage rates, changing home values, and market crash has you stressed, reach out to a member of our team. We’ll be happy to analyze your unique situation and discuss your real estate goals.
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