For example, average sales price of a house in the US was $477,900 in the fourth quarter of 2021, the St. Louis Fed estimates. I think that rice is unrealistic. Instead, I believe most houses in the United States are not worth almost half a million dollars.

America’s housing bubble is official. The Federal Reserve is issuing warnings about a housing bubble.

“There is growing concern that U.S. house prices are again becoming unhinged from fundamentals,” the Federal Reserve Bank of Dallas observes. That means housing prices exceed the true value of homes.

For example, average sales price of a house in the US was $477,900 in the fourth quarter of 2021, the St. Louis Fed estimates. I think that rice is unrealistic. Instead, I believe most houses in the United States are not worth almost half a million dollars.

Unfortunately, Mr. Market disagrees. He pays almost $500,000 for the average house.

The Danger from a Housing Bubble

Asset bubbles are dangerous because emotion drives them. To elaborate, exuberance and overconfidence motivate people to pay high prices because they believe prices will keep rising.

Frighteningly, the Dallas Fed’s exuberance indicator for the real estate market is over 95%. Hence, pure emotion could drive the boom around than market fundamentals. Hence, buyers are overconfident, which drives them to make poor decisions.

For example, a homebuyer could take out a $500,000 mortgage to buy a home in 2022. If the real estate bubble bursts in 2023 and the house price falls to $250,000 or $300,000. The buyer will have a mortgage that is $250,000 or $300,000 underwater.

Underwater is real-estate industry slang for a mortgage the home’s sales price cannot cover. Many of us remember the epidemic of underwater mortgages during the Financial Crisis of 2008.

Hence, one result of a housing bubble could be hundreds of thousands or millions of homes nobody can sell. In 2008, thousands of people walked away from underwater mortgages, leaving neighborhoods full of empty homes.

Another housing bubble nightmare is enormous amounts of “zombie properties.” A zombie property is a piece of real estate that never sells because the asking price far exceeds the market. The asking price is so high because the seller needs to pay off a huge mortgage.

How Housing Bubbles End

Housing bubbles can end in several ways, but all the potential outcomes are bad. I think there are three probable outcomes to the US housing bubble.

The first worst-case scenario is a sudden catastrophic collapse. To elaborate, the bubble bursts overnight because of some sudden economic or political development.

These developments could include war, a stock-market collapse, supply chain disruptions, a political crisis, sudden interest rate increases, policy changes, or a natural disaster. For example, the Great Florida Land Boom of the 1920s collapsed because of a hurricane and railroad executives’ decision to stop shipping building materials to the state.

The second best-case scenario is a gradual price decline as demand falls. That is prices slowly fall to a realistic level, instead of a sudden burst. Exuberance declines as the prices fall.

A third poorly understood scenario is stagflation. In stagflation prices stay high but sales decline because nobody is buying. For example, homes do not sell because most households cannot afford them. Stagflation creates enormous numbers of zombie properties as houses sit unsold.

I think America could see real-estate stagflation because most properties are mortgaged. Property will sit unsold because sales cannot generate enough money to pay the mortgages.

Stagflation USA

I think prolonged stagflation is the most probable outcome of America’s real-estate bubble. Vast amounts of property will sit unsold as owners wait for buyers. In particular, many people, including retiring Baby Boomers, will wait for cash buyers.

Hence, we will see another kind of destructive optimism. Buyers hearing all the stories of houses selling for ridiculous sums will wait for incredible prices that never come.

Stagflation can price most people out of the market, slowing sales and economic activity. As sales fall, the real estate markets will shrink and banks will be stuck with rising numbers of foreclosures and underwater mortgages.

Hence, America could enter a long period of economic decline driven by real estate stagflation. I predict we could see suburbs full of empty homes, cities full of empty condos, stores, and offices, and a nation full of dead real estate markets.

Dead Real Estate Markets

Consequently, many Realtors will find themselves selling cars, waiting tables, or driving Uber for grocery money.

Local governments will face the nightmare of dead zones of empty homes and businesses in many neighborhoods. One danger is a collapse of property tax and sales tax revenues, as empty properties pay no taxes. We could see communities full of million-dollar homes closing libraries and laying off cops because of shrinking municipal budgets.

Another problem will be an exodus of working and middle-class people who will flee regions where they cannot afford housing. Notably, California’s population fell by 173,000 people between July 2020 and July 2021, The Los Angeles Times reports.

Not coincidentally, California has some of the nation’s highest property values. For example, Zillow estimates the “typical home value” in Los Angeles was $944,641 on 5 April 2022. Conversely, Zip Recruiter estimates the average salary in Los Angeles in 2022 was $62,634 a year. Hence, ordinary people cannot afford homes in LA and I predict they will flee.

As workers flee prices for basic services will rise prompting more and more people to move. I think worker flight will make stagflation worse because there will be fewer and fewer home buyers. At some point, population decline could turn Los Angeles into the new Detroit – a city of empty neighborhoods and abandoned homes.

How the Great American Housing Bubble Could Burst

Although I think stagflation is the most probable outcome of the Great American Housing Bubble a sudden burst is always a threat.

One wildcard that could burst the Housing Bubble at anytime is Climate Change. Climate Change increases disasters such as hurricanes and wildfires. History shows such disasters can burst real estate bubbles. For example, historians think the 1926 Miami Hurricane and the 1928 Okeechobee Hurricane burst the Florida Land Bubble.

I think Climate disasters could burst the Housing Bubble. For example, a catastrophic heatwave could destroy property values in Arizona and Nevada, or a wildfire could destroy most of a city such as Los Angeles. Similarly, three or four giant hurricanes could destroy property values in Florida. Furthermore, a few months of flooding could destroy all of Miami’s real estate values.

Other outside factors that could burst the bubble include an energy crisis triggered by the Ukraine War, or a big interest hike by the Federal Reserve. A stock market crash, or the collapse of the US dollar could also destroy real estate prices.

One danger is that international events or civil unrest in the US convince foreign real estate speculators to pull out of the American market. To explain, foreign money, particularly Chinese, European, and Russian, is driving real estate prices in some markets.

For example Chinese buyers bought  40,600 American properties in 2017, 40,400 US properties in 2018, 19,900 properties in 2019, 18,400 properties in 2020, and 6,300 properties in 2021, Statista estimates. Hence, I calculate Chinese buyers bought 125,600 US properties in five years. What happens if Chinese owners start dumping all their US real estate.

I think a sell off of US real estate by Chinese or Japanese buyers could burst the real estate bubble and trigger a crash. Events that could trigger such a sell off could include civil unrest such as the 6 January 2021 Capitol Riots or race riots against Chinese in the United States.

Therefore, America is experiencing a gigantic real estate bubble that could burst at any time. However, real estate bubbles can last a long time. For example, the Great Australian Housing Bubble has been growing since 2000, 22 years.

I think the Great American Housing Bubble could be the greatest threat to the US economy. All Americans need to fear the Housing Bubble because it could burst and devastate our economy at any time.

Originally published at https://marketmadhouse.com on April 5, 2022.

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For example, Zillow estimates the “typical home value” in Los Angeles was $944,641 on 5 April 2022. Conversely, Zip Recruiter estimates the average salary in Los Angeles in 2022 was $62,634 a year. Hence, ordinary people cannot afford homes in LA and I predict they will flee.
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