Thread by @ReformedTrader

1/ Is U.S. housing in a bubble?

TLDR: Maybe. Valuations are consistent with this, especially considering real yields, but borrowers are also in better shape than in 2006.

Maybe build a one-sheet Excel model for expected housing returns and decide for yourself.

Thread

2/ Most of the realtors I've talked to tell me that the housing market is even hotter than in 2005, at least when metrics like months of inventory, days on market, and rapid price increases are concerned.

https://twitter.com/ReformedTrader/status/1416052444178489348

3/ Where I live, houses are on the market for <20 days on average, and buyers pay an average of 10% above asking and waive their inspection contingencies. Some are coming in with all cash.

Inventory (valuation) matters a lot in the short (long) term.

https://twitter.com/ReformedTrader/status/1407868554192379906

4/ Full-time cash buyers ("We Buy Ugly Houses" billboards) who are used to buying at 30% discounts can no longer do so.

Some are accepting 10%-15% discounts, which can be wiped out by transaction costs. Others, like Vena Jones-Cox, have stopped buying.

https://twitter.com/ReformedTrader/status/1399891647287029760

5/ Below, I list the arguments I've heard for this not being a bubble. One of them in particular seems solid; the others are more meh.

(But just because it's reasonable to tentatively call this a bubble doesn't suggest a 100% probability of a crash.)

https://twitter.com/ReformedTrader/status/1302337159303540737

6/ "Crazy 2005-type leveraged speculation isn't there in 2021."

This is a good point, especially with so many cash buyers. It's possible that we won't see a bubble-type crash, just years of stagnant, below-inflation returns until the after-inflation prices become reasonable.

7/ "Inflation is high, and housing is a hedge for inflation."

Neville et al. found otherwise. In the U.S., housing beat inflation in only 25% of extended high-inflation periods. Commodity futures, especially in a basket, do better. (Small sample, though)

https://twitter.com/ReformedTrader/status/1379188472750071809

8/ "Rates are low, so it's okay for prices to be high."

This is really an argument for low expected returns: "Bond yields are low, so it's okay to push up all other assets until there's not much left to squeeze out," especially w/ yields below inflation.

https://twitter.com/ReformedTrader/status/1407469742231670784

9/ "Housing is still affordable today."

This is probably not the case. After adjusting for inflation, today's housing prices are comparable to those at the bubble peak of 2005-6.

https://twitter.com/ReformedTrader/status/1433851823438262278

10/ "Owners are willing to pay a lot because they expect rents to go up."

The expectations hypothesis has historically not worked. In other words, today's rent (as a % of property value) is a better predictor of the future than owners' expectations are.

https://twitter.com/ReformedTrader/status/1188911052253040640

11/ If rental yields are low today, they will probably be low tomorrow. This has also held for stocks, bonds, currencies, and commodities.

Value+momentum help; IIRC, this is how Phil Tetlock created simple prediction models that beat most human experts.

https://twitter.com/ReformedTrader/status/1368022899131478018

12/ It's also the basis of the paper Value and Momentum Everywhere.

In other words, valuations (cap rates) matter, and momentum (probably related to metrics like months of inventory) also matters - but momentum is only a short-term predictor.

https://twitter.com/ReformedTrader/status/1190258717779849216

13/ Demers and Eisfeldt found that higher cap rates predicted higher total returns (yield + price appreciation). This risk-adjusted effect existed across metros as well but was weaker.

TLDR: Valuations have historically mattered for real estate.

https://twitter.com/ReformedTrader/status/1401567481290915840

14/ Also, any discussion of renting (long-term lease) vs. buying has to consider the returns you are giving up by owning a single house rather than a more diversified portfolio. The difference could be used to pay for private school & save up for college.

https://twitter.com/ReformedTrader/status/1411112122751148036

15/ So is housing in a bubble? Maybe.

We can probably say with more confidence that valuations matter, and they are currently very high.

Even if we're not in a bubble, low (even negative) cap rates suggest being even more careful than normal. Diversify!

https://twitter.com/ReformedTrader/status/1401573383188348930

16/ There are murmurs that I didn't state an opinion. It's true that I didn't make a bubble call (I don't think it's wise as a trader to state 100% probabilities).

But I did strongly suggest to sell the house and rebalance into a risk parity portfolio (though no one will do it).