What will cause the next housing crisis?

There's been a swell of coverage around the next potential housing crisis, many of these articles painting a gloomy picture of the general future of the market and more specifically the housing market. Take for example this recent article that walks through several factors that may (or may not) cause the next housing crisis. According to this article:

...investors and homebuyers should still be concerned about a housing bubble in their cities. Not all states have recovered from the last recession, nor benefited from previous Federal government policies. There really are  cities at risk of crashing.

Given so much investment into the housing market (and for many home owners so much to lose if the market did crash), a small team of us took a Harvard data visualization project and reflected it against this significant financial concern. The goal of our project: discover and illustrate likely key factors in the next US housing crisis. To illustrate the results of the project, we (i.e., myself, Ryan Gallagher, Hazem Salama, and Phil Teng) put together a web site with some interactive data visualizations as a summary view. In this post, I've taken our project and provided a bit more of a narrative to the work we did as a team.

Key Factors in the Last Housing Crisis

It was amazingly insightful (and scary) researching the run-up to the last housing crisis. I imagine many of you are aware, but subprime mortgages, the 'securitization' of those subprime mortgages into the market, and predatory lending (with quick expiration dates on the exotic mortgages putting qualified mortgage-holders into the sights of ballooning interest payments that they couldn't afford) were key influences on the last housing crisis. The impact of this run-up to the crisis that hit in 2008 can be seen below, where the House Pricing Index (HPI) plateaus just above 200 and then drops--only starting to recover in 2013. Interestingly, you can also see the dip and recovery of the housing market (expressed through HPI) with the most recent HPI at a historic high.

Try out the interactive HPI chart for yourself here.

State of the Current Housing Market

Per the above HPI chart, the state of the housing market is at an all-time high, with some US cities increasing at a much higher rate (e.g. San Francisco). In the chart below, you can see a trend chart with annotated averages for five major US cities (against the US average). San Francisco clearly has the steepest increase and top value out of any of the cities we looked at.

However, while the above gives you a sampling, the below choropleth map gives you a better indication of both state and city-based housing averages. The darker the shade of the state in the map, the higher the average housing prices. Further, the red circles represent the top 25 ranked cities by Zillow, so we made the radius of the circle larger or smaller based on the average housing price in that city. Below the map, you can also see the last eight years of inventory. So, in this case for the state of Washington, there has been a decreasing inventory of houses (in this case indicating a hot market), and the Seattle housing average is roughly $487,000.00; conversely, San Francisco average is $961,000.00.

To try out the interactive choropleth map for yourself, go here.

Factors to Consider in the Next Housing Crisis

We found a number of key factors as we explored a run-up to the next housing crisis, such as interest rates, age and income, income-to-debt ratio, foreign investment, geographical location and so on. In some of these factors, we observed a natural ebb and flow--likely influenced by the overall market bear and bull markets that drive higher and lower levels of income and capital availability. In other cases, we observed direct institutional policy (e.g. central banking interest rates) that impacted the market. Below, you can see a reflection of this time-based view where income growth drops into negative territory on a regular flow (typically between 5-10 years).

While we didn't explicitly look at it in our study, I did review unemployment (against a similar sample as the average housing in the line chart above) and found consistently decreasing unemployment in this sampling of US cities. The below chart shows decreasing unemployment for the last five years.

Lastly, we saw that interest rates can impact the housing market. For example, the below line chart shows the earlier HPI with the fluctuating interest rates across the same period. Generally speaking, as interest rates decrease, the housing market improves.

To try out the interactive chart for yourself, go here.

So, with the above, we might conclude that the following example factors impact the housing market:

• Lower interest rates improve the overall affordability and availability of mortgages.
• The broader market and its impact on income growth or decline impacts people's availability of income--to obtain and leverage credit.
• Unemployment impacts the ability for people to work, get paid thus to qualify for and sustain mortgages.
• Regional fluctuations in average housing prices will make housing more or less affordable for demographics (and also expose high price areas for increased risk against the broader market).
• Debt is a critical component to people's ability to get credit, afford a mortgage and thus buy a house.

However, we also observed data around two other key factors, and as we dug into the data these factors were significantly concerning to us.

• High levels of student debt.
• Future surplus of housing brought on by Baby Boomers.

These two factors, we believe, will drive a tipping point to the housing market--especially against a backdrop of other market tumult.

Student Debt and Baby Boomers

The high levels of student debt in the US are not exactly breaking news. The current value of student debt is at an all-time high of $1.5T. For example, below is a chart we put together reflecting the growth of student debt over the last eleven years. Incredibly, this could have a significant impact on not just the housing market but the overall market--especially given that the Millennial makes up one of the fastest growing employment profiles yet at the same time is dangerously saddled with such high levels of debt.

To try out the interactive chart for yourself, go here.

These high levels of debt are pushing the financial aid that students are taking on to unprecedented levels--those where post-collegiate working professionals have debt student debt well into their thirties. Thus, higher levels of debt (which increases this demographic's debt-to-income profile) decreases the ability for this population to qualify for mortgages. According to this article:

Millennials are a big question mark. The generation, born between 1985 and 2004 according to Harvard’s Joint Center, has been slower to buy houses than previous ones, including the smaller Generation X. This isn’t from a lack of desire but of affordability.

To substantiate the correlation between higher student debt and lower home ownership with some data, below is a chart created by the New York Fed Consumer Credit Panel (found here) that shows that higher student debt is associated with lower home ownership.

Now there are interesting trends within the Millennial population as well, e.g. more nomad-type working philosophy ("I want to work from anywhere"), increasingly moving to lower-cost cities (on the earlier choropleth map think moving inland to cities like Denver, Chicago, Austin, and so on), and of course increasingly renting. Our key takeaway, though, was a major part of a current and future working population may not have access to credit necessary to mortgage a house. In and of itself, this spells trouble.

Baby Boomers have a slightly different problem: they have property, which they will be selling into the market thus increasing supply. If this were a relatively small population, then this wouldn't be such a major issue; it may be more of a correction than a crisis. However, what we observed is that 80% of this population own homes (in some cases first and second properties), and simply put there will be a point in time where this population will sell off. Furthermore, over the past eight years, the Baby Boomers have been increasing the fastest in terms of home ownership. What reinforces our observation is the following projected population by generation trend of the Millennial versus the Baby Boomer (or Boomer in the chart below), sourced from this article.

According to the article:

Millennials are expected to overtake Boomers in population in 2019 as their numbers swell to 73 million and Boomers decline to 72 million. 

As a final view to understand how segments of the US population could (or could not) qualify for a mortgage, we built out a data visualization that enables you to compare key population groups. For example, below you can see different demographic groups such as the 65+ and 55-64 (given all of the variables listed in the chart) can in 2018 qualify for mortgages. What this means is these two groups have a lower debt-to-income ratio (below the 43% level). However, the other groups are either at risk or above that level of debt-to-income ratio--putting them out of qualification for a mortgage. This view begins to bring together many of the factors we researched in our project.

To try out the interactive chart for yourself, go here.

Final Thoughts

Nobody wants to lose value on what are in many cases a critical cornerstone of wealth in America. However, while we're seeing positive trends such as lower unemployment, we're also seeing broad market corrections and global trade disputes that are of consequence to the US (and global) market(s). This is the backdrop to our current state.

We see the current trend of increasing student debt (thus impacting the ability to qualify and afford mortgages) coupled with the future trend of Baby Boomers departing the market as a significant cross-road for the housing market. Worst case, we see a large surplus against a demographic that can't afford (and may not want) to buy--thus a crisis. Best case, we see a market correction with these two trends converging; the backdrop here would be positive market conditions and mitigating programs (e.g. mortgage affordability programs for high risk home purchasers).

Either way, without some manner of intervention and planning there will be impacts on the housing market. Our prediction: a housing crisis at worst, correction at best, will hit in the next 2-5 years. Two key factors will be the Baby Boomers and student loans, but we also see interest rates, income-to-debt ratio fluctuations, general markets, and other factors discussed in this blog post as an important backdrop to this future crisis/correction.