Home values are rising at unprecedented rates. Raleigh has seen a 36% increase in the last year alone! While this growth is great for homeowners, real estate experts agree that it isn’t sustainable. What they don’t agree on is what the outcome of a market slowdown will look like.

It’s easy to see why some think we’re headed for a disaster akin to the 2008 market crash. Many of the signals are the same, and the market is showing some bubble-like behavior. However, the underlying causes of this behavior are different, which means the shift will be less disastrous—and that’s what we’ve covered here.

One reason some experts believe that we’re on the verge of a market bubble burst are the similarities between today’s market and the market conditions preceding the 2008 financial crisis.

The real estate market crash wasn’t the only factor in the 2008 financial collapse. It included a stock market crash, high unemployment rates, and overall, the worst economic recession the U.S. had experienced since the Great Depression.

If we consider the real estate market crash as part of a recession while we look for cues, one significant one is a spike in oil prices. Consistently, these spikes have heralded major recessions.

The U.S. experienced the 1973 recession after the price of oil rose due to an oil embargo against the U.S. and other Israel-supporting countries in the Arab-Israeli war.

The 2008 recession occurred after the U.S. invaded and occupied the oil-producing nation of Iraq and gas prices rose over $4 per gallon for the first time in history (that’s over $5 adjusted for today’s inflation).

Now, Russia’s invasion of Ukraine has caused market players to reject Russian oil—which accounts for 13% of available oil overall. This shortage, combined with oil refineries recovering from pandemic-era capacity cutbacks, has caused the price of gas to hit its highest price since 2008. For some, this red flag indicates trouble for the U.S. market.

Exuberance sounds like fun, but in real estate… not so much. Exuberance is economic optimism based on a prediction of appreciation due to previous appreciation. It’s not based on the value of the asset itself. In real estate, the idea is that since the value of the home was going up, it’s going to keep going up, which makes it go up more. 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 keep rising until a correction occurs. When and why does that happen? When prices rise too high, investors can become cautious or policymakers might intervene. If those don’t stop the growth, eventually consumers will no longer have 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 Raleigh, home values have risen 36% in the last year alone, which is 12 times faster than the national average rate since 1891.

Home prices in an area must be obtainable based on the income in that area. If they’re not, houses sit on the market, inventory rises, and home prices drop until people can afford to buy them. Right now, home prices in the U.S. are nearing the limit of what incomes can afford—and in Raleigh, we’ve already surpassed that limit.

The general rule is that a home should cost around 2.6 times your annual salary. The current average annual income here in Raleigh is $62,745, while the average home value is $459,151. That means the average home in Raleigh costs 7.3 times the average salary.

Mortgage rates also impact housing affordability, which is why the Federal Reserve recently raised rates. This was done to deliberately cool the market by adding inventory, curbing uncontrolled appreciation.

A problem with this strategy of cooling the market is that some borrowers will then turn to adjustable-rate mortgage loans. These loans start with a temptingly low rate, but later in the life of the loan, they rise. When this happens, the homeowner’s mortgage payment grows—sometimes to the point where they can’t afford to pay it.

This was a large contributing factor to the 2008 real estate crash—and now, ARM loans are 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.

With this pile of signals so similar to the 2008 market, you might be wondering how we’re not headed for the same catastrophe. Don’t panic yet. There are key differences between that market and this one that indicate that the market will correct, but the results aren’t likely to be disastrous.

In the years leading up to 2008, banks overlent to consumers to fund derivatives backed by mortgages. This allowed tons of people to buy, driving up demand, which drove appreciation and eventually, exuberance. When the appreciation feedback loop eventually broke, those people owed more on their mortgages than their homes were worth, and many of them had taken out ARM loans they could no longer afford as rates went up. 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.

The current exuberance in the market isn’t being fueled by overlending. Instead, it’s being fueled by unexpected pandemic influences and in Raleigh specifically, population growth.

At the beginning of the pandemic, 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. Wake County is still gaining 64 people per day, so even as mortgage rates rise, demand is still high.

Home prices rose fundamentally at this point, which in turn caused a spike of homebuying fear-of-missing-out from investors, who started snapping up properties. This has created a positive feedback loop of appreciation based on appreciation, or, exuberance.

Exuberance isn’t sustainable, so our market will eventually correct. However, the results are not likely to be catastrophic due to these differences, and also because current lending practices are different.

If you bought a home both before and after 2008, you know that the requirements for obtaining a mortgage have changed drastically. Before 2008, anyone with a 720 credit score could get 80% funding up to one million dollars without income or asset documentation. This was considered prime lending, and these loans had low 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 the lengthy, complex process we’re familiar with today. Borrowers must now provide detailed documentation of their income and assets, making it more difficult to obtain a mortgage by design. In an effort to prevent mortgage default, the post-2008 application process allows only low-risk individuals to borrow money.

This is important because it means that a cooling market is unlikely to result in many home loan defaults. People who have mortgages can afford them, so market fluctuations are less likely to cause home losses.

The fact is, although Raleigh is in a hot seller’s market and still moves quickly, it is starting to cool off and slow down. Here’s how we know.

In the U.S., the number of homes sold has fallen for the third consecutive month according to the National Association of Realtors. This means fewer people are buying homes—likely a result of rising mortgage rates and high home-price-to-income ratios.

Meanwhile, inventory is rising. Inventory in Raleigh rose 7.1% in the last month, indicating that we’re inching toward a more balanced and cooler real estate market.

Raleigh’s housing market is unlikely to crash to the effect of the 2008 Great Recession, but expect a deflation in the near future, with economic experts predicting an appreciation slowdown and experienced real estate agents forecasting inventory’s return to normal in early 2024.

If you’re thinking of buying or selling but all this housing bubble talk has you stressed out, please reach out. At the Coley Group, we have the experience and expertise to answer your questions and help you make the right real estate moves.

If you just want to discuss your options for buying a home in Raleigh—please reach out. One of our expert agents will get back to you right away.