Do ‘Flashing Red’ Signs Mean That a U.S. Housing Bubble Will Soon Burst?

Is America in a housing bubble—and is it getting ready to burst?

That fraught question has become top of mind for buyers, sellers, and long-term homeowners alike. Many first-time buyers are coming to believe that a large-scale market correction—and the substantial price drops that would likely come as a result—could be the only way they can afford to become homeowners in this stressed, wildly overpriced market. But it has become the stuff of nightmares for owners who fear they purchased their home at the peak of the market and worry now that prices are about to plummet, diminishing their equity and devaluing their investment.

There are plenty of causes for alarm as home prices, after hitting epic heights this summer, are now beginning to fall as higher mortgage interest rates are hammering the market.

Sixteen of the 20 signs of a housing market bubble are “flashing red,” John Burns of the eponymously named real estate consulting firm wrote in a blog post earlier this month.

These danger sign indicators were compiled by 73 housing executives at a 2013 summit in the wake of the Great Recession. They range from somewhat frivolous social barometers (e.g., a preponderance of exorbitant housing industry parties spotlighted by big-name acts) to the primary economic indicators that led up to the 2008 housing crash, such as decreasing affordability of homes, falling sales, and waning demand.

Burns isn’t alone. Earlier this year, the housing bubble indicators the Federal Reserve Bank of Dallas follows “started to flash red as if we were back in 2004 again,” says Enrique Martínez-García, senior research economist and adviser at the bank.

So does that conclusively mean another bubble is about to pop?

Real estate experts across the U.S. have yet to reach anything close to a consensus on this. Many dispute the term “bubble,” and others are divided on its very definition. Some say today’s housing market is nothing like the one leading up to the housing bubble that ushered in the Great Recession. Still, others insist the nation is in the clutches of one that’s about to get really messy.

Then there are those who split the difference, believing that some of the real estate markets that got juiced during the COVID-19 pandemic, like Phoenix, could be in a bubble while the nation as a whole is not.

“The pandemic created a sugar rush for the housing market,” says Daren Blomquist, vice president of market economics at Auction.com. The site is focused on distressed, bank-owned properties, which often become foreclosures and short sales. “We’re finally coming back off that high.”

The one thing that most agree on: The housing market is undergoing a correction that will likely continue into next year. How drastic it will become is anyone’s guess. And it’s going to depend a lot on which direction mortgage rates go next.

“It’s hard to see any pleasant outcome,” says Aaron Brown, a mathematics and finance professor at New York University and a Bloomberg columnist. But “it’s not going to bring down the financial system.”

How today’s housing market compares with the mid-2000s

Before anyone gets too excited—or panics—there are some key differences between today’s housing market and the one in the mid-2000s that went bust.

In the lead-up to the last bubble, there were far more homes available for sale than there were buyers for them. The opposite is true today.

There were nearly four times as many existing homes for sale in 2006 than there were in 2021, according to National Association of Realtors® data that excluded new construction.

Builders, many of whom stopped construction during the Great Recession, currently can’t scale up fast enough. The dearth of homes on the market has been responsible for the record prices, bidding wars, and shockingly high offers over the asking prices during the pandemic as too many buyers compete for too few homes.

That demand, much of it coming from a large generation of millennials who are reaching the age when people typically buy homes, should prevent prices from going into a free fall.

“If you have a super [popular] item that everyone wants in on, you don’t tend to put it on sale. Prices typically hold up pretty good,” says Barry Habib. The CEO of MBS Highway, which provides housing and mortgage data and forecasts, does not believe the housing market is in a bubble.

The second big departure from the 2000s is mortgage lending isn’t built on a house of cards. Not just anyone can get a mortgage nowadays. Lenders have tightened their criteria for doling out money, and only the most qualified borrowers can score loans. That’s a 180-degree shift from the days when many lenders weren’t even verifying incomes.

Also, nearly all of those bad, subprime loans have been eradicated.

Most borrowers must put at least something down on a home, and payments typically don’t balloon over time to levels that borrowers can’t afford to repay. That’s what helped to trigger the mortgage meltdown that led to the Great Recession

People also have more equity in their homes. Even if home prices do go down, most homeowners will simply stay put to weather the real estate storm. If they lose their jobs and can’t afford their mortgages, they’re more likely to list their homes for sale than go into foreclosure. Many could even pocket profits. Without another wave of foreclosures flooding the market with cheap real estate, prices are expected to remain high.

“The biggest difference is when we had a price decline in the bubble, all of a sudden a bunch of people who could no longer afford their houses were forced to sell,” says Bill McBride, an economics blog writer at Calculated Risk who predicted the last housing bust. “That led to further price declines. There was just a cascading effect. If prices fall 10%, almost no one is underwater on their mortgages.”

Bubble or not, home prices could fall—a lot

Even with a stronger housing market, home prices could still fall. A lot.

Mortgage rates are more than twice as high as they were a year ago, making monthly payments significantly more expensive. Fewer buyers can qualify for loans. Those who still can are now able to afford only significantly cheaper homes than they could at this time just last year.

Most real estate experts anticipate the places that saw the steepest run-up in home prices and the most out-of-control bidding wars during the pandemic are the most vulnerable. Places like Austin, TX, Phoenix, San Diego, and Boise, ID, could see some of the largest corrections.

Real estate experts were divided on just how far home prices could fall in these places.

Habib, of MBS Highway, expects prices could drop 6% to 7% in these hot markets and dip just 1% to 3% everywhere else. McBride, of Calculated Risk, expects prices could fall 20% in these areas compared with a 10% decrease nationally.

“If you define a bubble as home prices are starting to fall, then we’re probably in one,” says McBride.

He does not think the country is in a bubble because the rampant investor speculation isn’t as pronounced today as it was in the 2000s.

“Housing is cyclical,” he says. “It’s boom and bust.”

And sometimes prices don’t plunge; they just flatten out. Through inertia, homeowners can experience minor losses because prices aren’t moving up in tandem with inflation. It’s not the best-case scenario, but it’s also not the worst.

“The most likely outcome is not an epic crash,” says Brown, of Bloomberg. “The most likely outcome is that prices stay flat for a few years, sellers won’t sell because they don’t want to sell at a loss, and everyone’s unhappy.”

Investors may be getting nervous

Runaway speculation was one of the hallmarks of the last housing bust. Investors were gobbling up homes to flip and rent out. They based their business models on the assumption that home prices would just keep rising in perpetuity. It was a self-fulfilling prophecy as all that competition for real estate kept pushing up prices—until the market crashed.

Even in the grim aftermath of the Great Recession, investors never fully disappeared from the market. HGTV built an empire around flippers like Chip and Joanna Gaines and Drew and Jonathan Scott, who became household names. And then investors ramped up again during the pandemic in a big way, with more iBuyers and institutional investors such as pensions and hedge funds getting in on the action, especially in the Sun Belt. Their mass buying in certain areas—often with all-cash offers—locked out many first-time buyers.

Many of the larger institutional investors today are on more solid financial ground than their predecessors of the early aughts.

That doesn’t mean investors aren’t worried. During the pandemic, they were willing to pay 9% less than the value of the distressed homes listed on Auction.com because they were confident that rising home values would ensure they received a hefty profit on these properties after fixing them up and putting them back on the market. In Phoenix, some were even paying 26% more than the estimated value of these homes. (More than half of Auction.com users are home flippers.)

Now, they don’t want to buy anything with less than a 20% to 25% discount—even in Phoenix. That’s not a good sign for the housing market as it means investors are less optimistic about their ability to turn a profit if prices don’t keep rising.

“What that means is a correction in home prices at the very least,” says Blomquist of Auction.com.

Home sales are down

The number of home sales is already dropping, and experts fear it could get worse. In September, sales of existing homes were down 19.9% compared with the same month a year earlier, according to NAR. That doesn’t necessarily signal a housing bubble, but it is worrisome.

Builders are also holding off on putting up as many new homes now that they’re not going under contract as quickly.

In his 36 years as a real estate agent and property manager in Las Vegas, ground zero for the last housing bubble, Bryan Kyle of First Serve Realty has never seen market conditions change so quickly.

He was sometimes seeing up to 20 offers on for-sale homes in the past few years. Now, some properties aren’t receiving a single offer.

But while he believes real estate is “stuck in the mud,” he’s seen much worse.

“When I think of a bubble, I think of what happened in 2008,” says Kyle. “That just brings back memories, thoughts, and nightmares of what happened all those years ago. I can’t imagine we’re in the same situation that we were in then.”

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