I recently wrote about research estimating that foreign investors are responsible for one-third of the rise in U.S. housing prices, making them significant contributors to any bubble. This week, I came across a short paper from the St. Louis Fed that looks at the current breakneck rally in residential real estate prices. It concludes that the current boom might be “the first nationwide boom since the postwar era not driven by increased demand for owner-occupied housing.” The first boom, that is, driven by investors.
The word “investor” associated with the word “housing,” these days, tends to send a shiver down the backs of many a financial pundit. “We’ve all seen what happens when investors drive prices,” Bloomberg economist Richard Yamarone recently warned in reference to that very St. Louis Fed paper. The implication is, I assume, that investors are a species particularly prone to irrational herd behavior and bull runs that might end disastrously. And because of these traits, such wisdom goes, investors often badly misjudge the true of value of assets in the economy, such as houses.
I actually think that’s a fair portrayal of investors. Unfortunately, though, that is also a fair portrayal of homeowners. When Robert Shiller talks about “irrational exuberance” — a term he borrowed from Alan Greenspan — he is talking about homeowners just as much as investors. “The great housing bubble of the 2000s,” he noted in a New York Times op-ed earlier this year, “was diffused widely through the population.” Homebuyers with dollar signs in their eyes taking on mortgages they clearly couldn’t afford were driven by the same ridiculous belief that drove the financial actors who repackaged those mortgages into securities—that housing prices could only go up. The idea that houses are assets you can bet on, rather than just places to live, has taken root among homeowners too.
That said, neither homeowners nor investors act on the basis of irrational exuberance all the time. Markets have a patchy record of assessing prices, but if they were consistently wrong, we’d have long ago gotten rid of Wall Street. So just because investors are driving the current housing rally, doesn’t necessarily mean there’s another bubble brewing.
The evidence, so far, is mixed. On the one side, as Fed chair nominee Janet Yellen noted in her first Senate confirmation hearing, there is a perfectly rational case for investors to load up on residential real estate. America’s homeownership rate has tumbled from 69% to 65% since 2009. With the economy sluggish and credit conditions still tight, few people are in a position to qualify for a mortgage. It makes sense for investors to snatch up cheap homes to turn over to a swelling population of renters.
Of course, the presence of a plausible narrative is no proof that a bubble doesn’t exist. Any bubble needs an optimistic story people can believe in. And there are signs in the current rally that the money is, in some cases, flowing to dubious places. The St. Louis paper, for example, notes that home prices are climbing in areas of the U.S. that have seen no growth, such as Detroit or Memphis.
With most of the housing market still at or below long-term valuations, though, it’s simply too early to tell whether there’s another bubble brewing or not. One thing is for sure: Taken in isolation the fact that investors are driving prices doesn’t tell us much.