Is the real estate double bubble back?
In the wake of the bubble, the Federal Reserve set out to create renewed asset-price inflation. It certainly succeeded with commercial real estate – a sector often at the center of financial booms and busts.
Commercial real estate prices dropped like a rock after 2007, far more than did house prices, falling on average 40 percent to their trough in 2010. Since then, the asset price inflation has been dramatic: up more than 100 percent from the bottom. In inflation-adjusted terms, they are up 83 percent.
This remarkable price history is shown in Graph 1.
Bank credit to commercial real estate has been notably expanding. It is up $238 billion, or 21 percent, since the end of 2013 to $1.35 trillion. It has grown in the last two years at more than 7 percent a year, which is twice the growth rate of nominal gross domestic product, although not up to the annual loan growth rate of more than 9 percent in the bubble years of 2000-2007.
The Federal Reserve also succeeded in promoting asset-price inflation in houses. U.S. average house prices are also back over their bubble peak—by about 2 percent, in this case. They have rebounded 41 percent from their 2012 trough. In inflation-adjusted terms, house prices a have climbed back to the level of 2004, when we were about two-thirds of the way into the bubble. See Graph 2.
The rapid house price increases since 2012 have not been matched by growth in bank residential mortgage loans or aggregate mortgage credit. Banks’ total residential mortgage loans were $2.45 trillion in 2012 and $2.41 trillion in the first quarter of 2017. Total U.S. 1-4 family mortgages outstanding went from $10.04 trillion to $10.33 trillion in the same period. Thus, there is a marked difference between the two real estate markets, with commercial real estate having even more price inflation and more bank credit expansion than houses. The interest rate environment is, of course, the same for both.
House prices and commercial real estate prices are closely related. As shown in Graph 3, they made an obvious double bubble, a double collapse and a double big rebound. The statistical correlation between the two since 2001 is 86 percent.
Is what we have now a new double bubble, or something else? Considering where these charts may go from here, we may ponder three key questions:
- If interest rates go up 1 percent or 2 percent, what will happen to commercial real estate and house prices?
- If the Fed stopped being a big buyer of mortgage-backed securities and bonds, what would happen to interest rates?
- Having driven asset prices up, by buying and maintaining huge long positions, can the Fed get out of these positions without driving prices down?
We will know the answers when, sometime in the future, somebody explains it all to us ex post. For now, we know that real estate prices are back to the levels of the last bubble, reflecting the Federal Reserve’s production of asset-price inflation through its interest rate and bond market manipulations.
Image by Noah Wegryn