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Response to Denver Post article

Charles Roberts, co-owner of Your Castle drafted this open letter to the Denver Post… (emphasis below is mine)

The Denver Post published an article this morning called “Denver housing market enters danger zone, economists say” suggesting the housing market in Denver has peaked and is heading for a downturn and many of you asked what our reaction to this is. Some of your clients are worried and hesitating to buy and you’re looking for a reaction. Here are two quick thoughts:

  1. It’s important to remember that the job of the Denver Post is to sell newspaper advertising which means they have a large incentive to write intriguing copy which may or may not make any sense at all. Our job is to give our clients thoughtful, professional advice. They are two very different things. Anyone who makes a decision to buy or not buy a home based on an article in the newspaper needs lots and lots of help better understanding the real estate market, something we’re very good at.
  2. Nobody can perfectly predict the real estate market. Nobody! Not the Fed, not the big banks, not Wall St., and certainly not the Denver Post. And we can’t either. All we can do is assemble the copious and relevant data and try to make some sense of it in order to advise our clients. Choosing a single metric as the Post has done and trying to predict a downturn is at best misleading, at worst downright scandalous.

Will we have a correction “in the months and years ahead” as the Post speculates? Sure. Someday the market will peak and start to settle down. But I don’t think it will happen for a number of years for several reasons, such as:

  1. Even with the increase in metro Denver home prices the Housing Affordability Index is still well above the rate it was during the last upturn in the market between 2002 – 2006. The HAI is the median price of a home compared to the median income, taking into account the prevailing mortgage rate. So, given that homes are still relatively affordable given median (and, by the way, increasing) wages and low interest rates, we haven’t entered bubble territory.
  2. The number of transactions relative to the population of metro Denver is just about at the 25-year average. At the peak of the bubble in 2006 the number of deals was about 20 percent percent above the historical average. When we see the number of closed transactions well above our historical average that’s an indication to me of an overheated market, as it was in 2006. We’re nowhere close to that.
  3. As we led up to the last bubble in 2006, many of the deals were closed with low or no documentation (“liar loans” or “no doc loans”). Today, mortgage underwriting standards are the toughest they’ve been in decades. This prevents unqualified buyers from purchasing property, which mitigates the chance of the market overheating (fewer buyers means fewer purchases means less chance of the market frothing into bubble territory like it did in the past).
  4. Because of reasonable home affordability it’s still cheaper to buy than rent in our market, especially at the lower end. This would not be true in a bubble. For housing price affordability to return to the average level that we saw in the years between 2002 and 2006 either home prices would have to increase an additional 20 percent or interest rates would need to reach 6 percent. Neither is going to happen any time soon.
  5. The imbalance between buyers and sellers we’ve seen recently in our housing market is due to a lack of inventory, not illogical/unrealistic/unsustainable demand from buyers. This imbalance is a logical correction from the past downturn years when we had too FEW buyers in the market. This is how markets are supposed to work, moving in cycles and always regressing to the mean over time.
  6. Rising mortgage rates will help to temper the possibility of a bubble as well. So the positive side of a rise in mortgage rates is that it will reduce the number of buyers and therefore reduce the chance the market will rise out of control and end up collapsing in a bubble.

Here are a few metrics I watch closely to look for signs of a weakening housing market:

  • Housing inventory. When the inventory of homes for sale rises, supply will begin to balance with demand and slow the price increases. We’re still at record-low inventory so I don’t expect to return to a balanced market for several more years.
  • Number of homes sales. If we see a spike in homes sales (most likely due to increased inventory of homes coming on the market) we can expect a slowdown in the housing market to follow just as we saw after our home sales spiked in 2006. At this time, we are right at the 30-year average of homes sales/year/capita which tells me the market is not overheated.
  • The economy. Metro Denver has a booming economy which is contributing to our strong housing market. If the economy begins to falter that will affect housing. I see no sign of that happening anytime soon.
  • Interest rates. Low interest rates have contributed to relatively high home affordability, continuing to help the housing market. If interest rates spike that will decrease affordability. But no one can predict interest rates and trying to do so is simply a waste of time.

For these and many other reasons I believe our market will continue to be strong for the foreseeable future, but of course it can’t grow indefinitely. Since the inventory of homes for sale is still extremely low I think the demand will still exceed the supply for the next 3-4 years and prices will continue to rise for at least the next few years. No bubble on the horizon yet. Stay tuned!