Is real estate a good investment in 2018? While not as dicey as in, say, 2008, it is fraught with substantial risk. The parts of the country with strong economies have overheated real estate markets featuring prices out of proportion to household incomes. The places where real estate prices are more reasonable tend to have softer economies and job markets, and less positive growth outlooks for the coming years.
Real Estate Rising
Since the real estate market collapsed during the Great Recession, buyers who braved the deluge of negative headlines and purchased at the market low points have been rewarded. From the first quarter of 2009 (the nadir) to the first quarter of 2018, the median home sale price nationally rose by nearly 60%, according to U.S. Department of Housing and Urban Development (HUD) statistics.
In certain cities, however, the run-up was especially significant, including San Francisco, Phoenix, Miami, and Las Vegas (both of which were wrecked in the recession). Home prices are even above their pre-recession peaks in 57 of 105 metropolitan statistical areas (MSAs), including Houston (up 69%), Dallas-Fort Worth (67%), and Denver (62%), according to an April 2018 ATTOM Data Solutions U.S. Home Sales Report.
Home Prices and Household Incomes
Real estate prices are only sustainable as long as people can afford to buy homes. The law of supply and demand dictates that if buyers stop buying, prices fall in response. An easy way to determine if housing prices exceed the level that buyers can comfortably afford is to compare them to household incomes.
Household finance experts recommend spending no more than three times your annual income on a home. Over the long-term, U.S. housing prices have hovered around that ratio.
However, home prices grew disproportionately to household incomes in the booming economy following the Great Recession, according to real estate economist Mike Fratantoni of the Mortgage Bankers Association. For example, buyers in San Francisco were stretching their budgets to buy homes that cost several times what they made each year. The story is similar in other major cities, such as Denver, Miami, and Seattle, all of which have seen housing prices ascend rapidly, even as incomes made only small advances.
Before the real estate market imploded between 2007 and 2008, median home prices were more than 4.5 times median incomes—one of the factors leading to the subprime mortgage meltdown. As prices approach this threshold once again (as of May 2018, it was at 3.83), buyers should exercise caution and avoid jumping in right at another market peak.
Where the Bargains Are Found
Certain cities still offer reasonable housing prices in relation to how much residents earn. In St. Louis, for example, the price-to-income ratio hovered right around the long-term benchmark as of year-end 2017. Unfortunately, the city has evinced none of the growth and price appreciation seen elsewhere since 2011. In fact, prices have declined slightly during that time.
Chicago is another city that features affordable homes, but its prices have also dipped since 2011, and the city’s unemployment rate, as of August 2018, was in the upper third among the 50 largest U.S. metropolitan statistical areas.
The Bottom Line
The conundrum with the U.S. housing market is that the best-performing cities are becoming overheated and unaffordable, while the places with affordable housing don’t have the greatest outlooks for the future.
The real estate bull market, which is going into its seventh year, is making housing hot again. Based on Warren Buffett’s advice, however, investing in what is hot is not the way to succeed financially. The last smart time to buy real estate play was in 2011, when the masses were still trampling each other to get to the exits. Now is the time to seek out undervalued investment opportunities elsewhere.