Think We’re Headed Toward a Housing Market Crash? That Mindset Will Prevent You From Making Smart Investments.

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Do you want to invest in your first or next property, but find yourself wondering if you should wait for “the crash” before jumping in? If so, you’re not alone. I’ve talked to countless people—from experienced investors to my personal friends and family who are just looking for a primary residence—who are all questioning whether they should buy now or “wait for the crash.” 

This is a natural question. No one wants to buy at the height of the market, only to see property values decline for a few years. However, this question also demonstrates a fundamental misunderstanding of the normal cycles in the housing market. The housing market doesn’t actually “crash” on a regular basis, and the belief that it does is preventing people from making sound investing decisions. 

In my opinion, the basis of this crash fear lies in the trauma of living through the Great Recession and housing collapse in the late 2000s. I call it “housing market trauma”—not in an attempt to make light of it—but rather to give a name to something experienced by many. 

How normal economic downturns affect our investing decisions

I completed my undergraduate degree in the spring of 2009, which was, at the time, the worst job market we’d seen since the Great Depression. (Sadly, I think the class of 2020 now holds that unfortunate record.) And, the events that occurred due to the Great Recession significantly impacted my financial outlook and decision-making. 

At that point, it was very difficult for me to find work and support myself post-college. As such, that experience shaped the decisions about the jobs I’ve taken—as well as my decision to obtain a graduate degree to ensure I was employable. And, it also directly impacted my decision to start investing in real estate at a young age, which was done in order to generate multiple sources of income.

And, these types of economic events haven’t just impacted me. They’ve impacted the way we all make decisions about money and investing.

For example, in the late 2000s, people across the United States watched as housing prices declined by nearly 20%—and as millions lost their jobs and homes. As such, it’s no surprise that, as a nation, we’ve lost some faith in the housing market. What happened during the Great Recessions was historically bad, and people rightfully want to understand the risks of homeownership and real estate investing. 

To do that, let’s look at the history of the housing market, and put the events of the late 2000s into context. 

If we look at the median home price in the  U.S. dating back to the early 1960s, you’ll see that the housing market does not regularly decline. In fact, it has only crashed once. (Note that I define a crash as a decline in assets of more than 10%). 

Note: This graph is not adjusted for inflation. If you want to check out inflation-adjusted home prices, you should head over to the blog Don’t Quit Your Day Job. It’s worth checking out because prices do decline more dramatically and for longer periods of time when adjusted for inflation. I am choosing to look at nominal prices (“nominal” just means “not adjusted for inflation”) because that is how most people are used to looking at housing prices, stock returns, income, and just about everything else. 

Other than what happened in the late 2000s, there are two prolonged periods of flat or negative growth: 

• In the early 1990s, the U.S. housing prices, in nominal terms, dropped about 8%—but gained back half of the losses within a single quarter, and prices returned to previous highs in about two years. 
• At the end of 2017 prices were flat or down—and this continued for a few years, with an initial drop of 5-7% nationally, followed by a flat period that lasted about 3 years before prices recovered. 

These types of flat or negative growth periods are what I would call normal market cycles. Things cannot always go up. Even in a healthy economy, prices will flatten or decline for periods between economic expansions. 

But what about the crash in 2007?

On the other hand, what happened back in 2007 was a whole other animal. Starting in the first quarter of 2007, an actual crash occurred. Housing prices dropped by 19% nationally before bottoming out in early 2009. It would take until 2013, a full six years later, for prices to recover. 

From a historical perspective, what happened in 2007 was unprecedented. This was a genuine crash accompanied by a historic recession—and it was generally just a mess. But it was awful, and it’s natural that many people in the U.S. are worried this could happen again. 

But just because the last contraction was historically massive doesn’t mean that the next one will be, too. In fact, it’s unlikely that the next down period in the housing market will come close to what happened in 2007.

Could it happen? Yes. There is certainly a risk that the housing market crashes again, but it seems unlikely based on the housing market’s fundamentals. 

I’ve written about this extensively in prior posts, but let’s review.

The 2007 collapse was fueled by a number of factors, but two directly related to the housing market are speculative buying and building, and very loose credit standards. These are two conditions that don’t exist today. 

New construction in 2007 vs. now

Let’s start by looking at new construction in the U.S.

As has been well documented, construction in the U.S struggled to recover from the Great Recession. It’s been nearly a decade, and yet construction rates have only recently reached the levels that existed in the late 1990s and early 2000s. 

In fact, most experts like the National Association of Realtors, and Freddie Mac believe this has led to a historic supply shortage of between 4 million and 7 million homes in the U.S. 

I believe that this is something to keep an eye on as construction numbers continue to grow. That said, I don’t think we’re at the point where there’s a huge risk of over-development (at least on a national scale, some individual markets may become overbuilt). 

Credit standards in 2007 vs. now

Secondly, credit standards are different now than they were in 2007. After the Dodd-Frank Act was passed, mortgage standards were tightened significantly. The first dataset I like to follow is Mortgage Originations by Credit Score.

See those dark blue bars from 2003-2009 at the bottom of the graph below? Those are subprime mortgages. Notice that they have almost completely disappeared, and are instead replaced by mortgages taken on by people with credit scores above 760. 

There is plenty of other data that supports this. All you have to do is search for the Mortgage Credit Availability Index, or the disposal income to debt service ratios, to find it.

This data shows that Americans are much better positioned to service their debt today—even with increased home prices—than they were in the late 2000s. 

For these reasons and others—strong demographic demand, relatively low interest rates, and the volatility of other asset classes, to name a few—I believe the most likely outcome of the next down period in the housing market will be much less severe and shorter-lived than the crash in 2007. 

In other words, while the downturn will have to come sooner or later, it won’t be nearly as impactful as it was back then.

Other factors to consider about the current housing market

Here are a few other things to consider: 

1. Although I personally believe we will see price growth through at least the end of 2022, the housing market will decline or flatten in the coming years.  This is normal—and to be expected. And, when it happens, please don’t let people who have been predicting a crash since 2014 claim they were right. 
2. It is extremely hard to time the market. Many prominent investors have been calling crashes for years and they’ve all been wrong. I don’t think the market will decline in 2022, but I could very well be wrong. Timing the markets is hard, and I don’t recommend trying to. 
3. If you find a good deal right now, take it! The market could go up another 15% before declining 15%. Or it could decline tomorrow. We just don’t know! In times like these, it’s important to focus on your personalized deal criteria and stay disciplined. But, if you find a deal that fits your long term strategy and financial goals, take it and don’t look back. But, as always, make sure you have liquidity to cover all expenses (and then some) to ensure you never have to sell at the bottom of the market. 
4. Lastly, don’t panic if things go down. The worst possible time to have purchased real estate in the history of the U.S. was probably the beginning of 2007. But even if you bought the median prices home in Jan of 2007 and held on until today, your property would have averaged a compound annual growth rate (CAGR) of nearly 5% over the last 15 years. Not a home run, but that’s buying at the worst possible time. If you add on the roughly 5% CAGR you’d get from loan pay down over that time, you’re at 10% annualized returns, and that’s without considering tax benefits or any cashflow! If you held on, it didn’t turn out that badly at all. 

Final thoughts

If you want to get into real estate investing, don’t dwell on the trauma of 2007. Yes, housing prices will go down again, and it will be difficult when it happens. But no one, myself included, knows when that is going to happen. So don’t try to time the market. I know the market will go down in the coming years, and I am looking to buy now anyway because a mortgage at 3.5% is still an incredible opportunity. 

Determine for yourself what a good deal is. Once you do, go out and find something that meets your criteria, buy it, and hold on to it for a long time to come. 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.