The Next Bubble Is Not Tech

Wall Street Is Too Preoccupied With Big Tech to Notice a Bubble Growing in Real Estate

For two years now the focal point of financial outlets was the United States stock market. It’s not unjustified either – the gains in the technological sector were frankly incredible. That cast many sights on the IT industry and its prophesized downfall due to unsustainable growth. While that is proving to be the case less and less, a sector outside the stock market is bubbling up frighteningly fast to no one’s surprise or concern. Real estate is red hot, and it might be due for a correction sooner than many think.




The State of Real Estate

It’s no secret that since 2020 the world hasn’t been the same. The month of May marked the beginning of a price crisis nearly everywhere in the world. A lot of money in circulation in the economy and not enough production prompted price levels to rise continuously. By definition, we were all in a period of high inflation.

It was a difficult period for many people. Since 2022, inflation in the US, as expressed by the Consumer Price Index, has gone down significantly. Currently, it’s just about 2.5%, which is quite close to what can be considered normal for sustainable growth of the economy.

Economic indicators are showing a recovering US economy, which is reassuring news for economists, but ask any ordinary person if they’re feeling better off and you’ll get quite a different answer. In fact, many are feeling worse off, and the reason is simple. Just because the rate at which price levels are increasing is slowing down, it doesn’t mean that actual price levels are decreasing.

$1,000 back in 2020 are worth as much as $1,219 today. This is almost a 22% total increase in prices. In other words, on average, the US citizen has lost a fifth of their buying power over that period. That is, unless they have received a salary raise or investment returns that offset at least some of those losses.

Prices are high and for many goods and services they are not going back down. One asset class that experienced a boom during that period was real estate. It’s not talked about as much as the stock market is but that’s mainly because unless you own rental properties or are in the business of flipping houses, there’s not much you could do with price movements there.




On the chart here we have the S&P Real Estate Select Sector Exchange-Traded Fund (NYSE:XLRE) in blue and US inflation in red. The ETF tracks the real estate sector within the S&P 500 broader economy index. It encompasses holding companies that profit from rising real estate valuations. It’s more than obvious that the pandemic triggered a rapid increase in both inflation and property prices.

What’s interesting, however, is that real estate has become a lot more expensive than other parts of life. An average property in the US costed, on average, $250,000 at the start of 2020. Now, it’s approximately $362,000, according to the Zillow Home Value Index. In percentage terms, that’s a nearly 45% jump for the period – or more than twice as much as inflation for the same time frame.




Homes became that much more expensive due to a dangerous combination of factors. Because of lockdowns, many industries were left motionless for some time. One of those was construction. When there are fewer buildings erected, supply becomes tighter. Simultaneously the rising inflation was eroding the purchasing power of people’s money, which meant that the developers still in business had to pay more for materials and salaries.

To add insult to injury, some of the largest asset management companies on the planet such as BlackRock were already embroiled in eating up family homes and putting them up for rent. This has led to an unconventional divergence between inflation and property values as of recently, which some economists claim is not going to reverse any time soon.

Why Everyone’s Wrong

Only a handful of people saw the housing market crash coming in 2007. The ones that had actually done their due diligence noticed that the rate at which people were buying properties was unsustainable to say the least. No financial background checks and cheap capital allowed nearly everyone to secure a mortgage on a house.

After the inevitable crash that ensued after millions of Americans were unable to pay off their mortgages, it seemed impossible for such an irrational event to take place again. Banks started scrutinizing their clients more, buyers became apprehensive about punching above their weight by buying incredibly expensive properties, and builders scaled their business back to reflect the new market reality.

Seventeen years later, real estate is running red hot again. Prices are on the rise and many people can’t afford to pay them. This time around, it’s not the number of houses selling that is problematic, it’s their price tags.




A market bubble is essentially an overinflation of a price for an asset beyond what is fundamentally its true value. This happens in part because of speculation. If many people are convinced the only way for the price to go is up – they can start buying without any regard for fundamentals. This can propel the price much higher than what buyers would normally pay for the asset.

Bubbles are described as having five stages. In the first one called displacement, an innovation or a disruptive event appears on the market that challenges the norm and gets people interested in an asset. In the case of real estate, this can be attributed to the hugely stressing COVID-19 pandemic. It caused many people to consider relocating away from urban centers and into suburbia as remote work becomes more and more common.

Followed by the displacement is the boom. This is the point at which prices rise despite indicators that suggest the opposite should happen. For instance, both inflation and mortgage rates rose significantly in the past couple of years yet that didn’t deter buyers all that much. There was a push to own property at any price.

Euphoria follows. This is when the fear of missing out (FOMO) meets the belief that prices will continue rising indefinitely. This is the crucial moment when speculation comes into play. Institutional investors such as Blackstone (NYSE:BX) and BlackRock have a history of purchasing residential real estate with an investment purpose. This trend picked up the pace thanks to the period of cheap capital between 2020 and 2022.

Many residential properties now are being bought above market price by large companies, so they can be rented out to generate cash flows. This endeavor is profitable for the real estate companies which benefit from rising house and rent prices. Simply put – the more they are buying, the more expensive they make property cost.

Profit-taking and Panic are the last two stages. In the former, you get people starting to cash out on their investments as they feel the price peak has come. When the unloading of the assets begins, panic ensues. The overinflated prices have deterred true buyers in the market because they have been priced out, leaving very few people left that are still willing to buy at high prices.

Then, everyone wants to get out and realize a profit before the price collapses back to its average price. While the last two stages haven’t transpired yet, they seem more and more likely by the day.

The Property Bubble’s Winners and Losers

The problem in 2007 was that property was sold left, right and center. Today, the problem is people can’t afford it anymore, and it’s all too easy to chalk it up to the cost-of-living crisis or inflation. It’s hard to notice there’s something wrong when everything is going wrong.

So, what’s the takeaway from all this? If the real estate market is doing “well” according to real estate companies, is there really a problem? Well, it’s going to be doing well only so long as there are people looking to buy at higher and higher prices. What are the odds that will continue indefinitely?

In any investment that relies on a ‘greater fool’ to pay more and more, at some point there will be no more fools left to buy in. And then, something’s got to give. The ones that profit from the high prices are those that own residential housing and rental properties. If people are no longer willing to pay the high prices, what kind of profits will they generate? Something’s worth a lot of money only if there’s someone willing to pay it. And if not, well, the bubble bursts.

What’s not going to burst, though, are the builders. The same companies that scaled back production when the market got choppy are picking up the pace. Construction is speeding up thanks to affordable housing initiatives and high demand. But the tipping point will come with the US rate cuts which are now more than probable considering inflation is under control.

Decreased cost of borrowing is a key factor for developers because construction can be heavily financed with debt. The SPDR Homebuilders ETF (NYSE:XHB), which tracks major real estate development companies has been outpacing the SPDR Real Estate ETF for more than twelve months now, showing the increasing profitability of the former compared to the latter.




Real estate holdings do benefit from the high property and rent prices, but a flood of new homes can potentially erase that profitability. What might happen to their share value and bottom line if they can’t charge nearly as much for rent anymore? And conversely, could intensified construction be profitable for the homebuilders?

If people are fed up with the high prices and stop renting or buying for a high price, would that reduce the demand for expensive real estate? And if the low interest rates turbocharge development, would that increase the supply in the market? Is it possible that the prophesied indefinite value rise might grind down to a halt?

And if it does slow down enough, would people start taking profits or perhaps even panic selling? Could real estate prices take a plunge once the wave of cheap capital construction finishes in the coming months and years? Could the 191% boom in the Homebuilders ETF repeat during a period of 0% interest rates? Only time will tell, but smart investors know that history has the tendency to repeat itself.




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Technical Analysis of SPDR S&P Homebuilders ETF (XHB)




Uptrend Channel:

• We can discern an upward channel forming on the daily logarithmic chart indicating a steady uptrend for the past 323 days. The price has consistently found support at the lower trend line, showing that upward momentum is strong.

Key Levels:

• $85.13: Weekly key level and all-time high in November 2021. Acted as a resistance three times throughout 2021 and 2022. More recently, in August 2023, the price reached this level again as resistance. Could potentially act as a strong long-term support.
• $105.55: Weekly key level. Over the majority of 2024, the price has had multiple weekly closes near $105.55, establishing it as strong support.

Fibonacci Retracement:

• Plotting an inverse Fibonacci Retracement between the lower and upper boundary of the uptrend channel, we can see that the weekly key levels correspond to the 0.618 and 1.272 levels, indicating that these are potentially significant. The 4.764 extension level corresponds approximately to the $330 price level, which also marks a potential 191% gain from the market price. This level could serve as a potential long-term price objective should the uptrend channel be respected.

Conclusion:

• The SDPR S&P Homebuilders ETF (XHB) shows a strong bullish trend supported by key technical levels and indicators. The $85.13 and $105.55 levels are crucial support, with $105.55 consistently holding throughout 2024. The ETF's uptrend channel and adherence to the lower trend line suggest continued upward momentum, potentially reaching the upper channel trendline. A Fibonacci retracement analysis confirms the significance of the weekly key levels as support and aligns with the potential long-term price target of $330 at the 4.764 extension level.

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Contributions

Technical Analysis provided by Tiago Afonso, Banxso Market Analyst.