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Is a Real Estate Bubble Forming?

For those of us who’ve been around through a crash or two, there’s always a bit of nervousness when an economy or a market seems to be growing too fast, or the returns on our investments seem too good.

 

Right now, is a time like that here in USA. Unemployment is at all-time lows. Wage growth is high and GDP growth is high. Everyone is doing well. That’s also reflecting in the housing market– prices are rising, rents are rising and we have a great choice of tenants for each house we put on the market.

 

So, can it be too good to be true? I think the answer is more complicated. In many parts of USA, there are indeed signs of a bubble – prices are often jumping due to lack of inventory, rather than higher actual demand. Yields are so low that investments are often in negative cashflow if there’s a mortgage on the home.

 

I like to focus on the fundamentals when I look to value a home – the bricks and mortar value if you like. Buffalo has seen extraordinary house price growth and rental growth in the past 5 years, but in the main rental areas we focus on, prices are still below what it would cost to build the new house. A $100,000 house would still cost $150,000 to build new, so there’s no reason for developers to build new houses. This means contractors are busy rehabbing and upgrading existing homes, which pushes prices up towards the replacement cost but we still have a long way to go in many areas. Buffalo’s west side is the latest area to get to around par on build cost/replacement cost, but the main investment areas we work in (South Buffalo, Blackrock, Riverside, University, Cheektowaga) are still around 50% below rebuild cost. Buffalo also remains one of the most affordable housing markets in the USA. (s) On top of this, as a failsafe, gross yields are still over 15% giving positive cashflow, even with a mortgage. This leads me to conclude that Buffalo is still nowhere near bubble territory –however, there’s never room for complacency. If rents stay the same, and prices rise another 50%, then it becomes attractive for builders to increase the supply of homes, which always puts downward pressure on prices. When that day comes we can re-evaluate our options, but for now – if it’s not profitable for builders to build, then we’re not in a bubble.

 

Further reading:

https://www.nytimes.com/2018/05/04/business/economy/jobs-report.html

https://money.cnn.com/2018/06/01/news/economy/may-jobs-report/index.html

https://www.telegraph.co.uk/business/2018/08/29/us-set-decade-high-gdp-growth/

https://www.cnbc.com/2018/06/06/us-house-prices-are-going-to-rise-at-twice-the-speed-of-inflation-and-pay-reuters-poll.html

https://www.businessinsider.com/rental-prices-are-soaring-around-the-us-2018-7

https://www.investors.com/news/the-most-affordable-major-housing-markets-are-in-u-s-survey-says/

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