What is a Housing Bubble and Why Do They Pop? 5 Important Things You Need to Know
If you have paid attention to real estate for any period of time, you have likely come across the term ‘housing bubble,’ but what does it mean? Regardless of whether you are a seasoned investor or a new buyer looking to enter the market for the first time, you should know what a housing bubble is, and what you should do if it pops.
Many homeowners and investors show consistent concerns regarding an impending housing bubble, and it is completely understandable. The Great Recession of 2008 is not far beyond recent memory and plenty of experienced investors witnessed the impacts of an unforeseen housing bubble first-hand.
However, much like many investors powered through the 2008 recession and recovered alongside the housing market, it is possible to prepare for and survive a housing bubble bursting if you play your cards right.
First, if you are worried about a housing bubble, the first thing you should do is talk to a mortgage professional to ensure your financing is set up sustainably in case the market declines later. To start that process today, click the link below for a free strategy call today.
What is a Housing Bubble?
A housing bubble – also referred to as a real estate bubble or property bubble – is what happens when the price of residential real estate rises sharply due to external demand. Instead of homes naturally appreciating over time due to inflation, a housing bubble will see these houses becomes increasingly more expensive due to high demand or speculation.
Eventually, this leads to properties becoming over-valued and unaffordable for the majority of buyers.
What Causes a Housing Market Bubble?
Housing bubbles are triggered by a combination of different factors that all contribute to high demand and sharp price increases. These factors can include:
A Healthy Economy: Surprisingly enough, a healthy economy is often one of the earliest factors that cause a housing bubble. This is because when the economy is thriving people have more disposable income and are free to buy real estate, introducing new demand to the market.
Low Mortgage Rates: Low rates can contribute to high demand for residential real estate because it becomes easier for more individuals to qualify for higher mortgage loans. This allows for more competition between buyers for cheaper properties, and new demand towards properties in higher price brackets.
Relaxed Lending Guidelines: During the 2008 recession, many lenders made loans to unqualified borrowers who could not afford to repay their mortgages later. These relaxed guidelines increase the ability for people to enter the market, but do not assure that they can afford to remain there.
Speculation and Poor Investments: While real estate is often a very reliable investment, many speculators fail to identify over-valued properties under the belief that they will continue to rise. This makes the market more volatile.
While most of these factors are not problems of their own right, once they are combined together under the wrong circumstances and left unchecked, they can lead to bigger problems.
Know the Warning Signs
Often people only are able to recognize a housing bubble after the fact once the crash has already occurred. However, there are key indicators you can look for in order to spot a housing bubble before it is too late.
By comparing home prices to prices during previous periods of growth, it can be easier to identify patterns between natural growth periods compared to artificial growth caused by unsustainable demand.
In addition to those trends, economists also refer to the average valuation of houses (the cost of housing vs the average affordability) and the amount of debt being carried by homeowners.
These are used to estimate how affordable the housing market is for residents living in the affected region.
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What Happens if the Bubble Bursts?
As the saying often goes, every bubble has to pop. Eventually once a certain threshold has been crossed, a housing bubble will almost always pop. When this happens, housing prices would begin to drop dramatically, but even then it may not be immediately noticeable.
Unlike the stock market which can crash in less than a day, real estate declines at a much slower rate. This is because people who are offering properties are not willing to immediately tank their prices and instead will slowly reduce them in hopes that they can still manage to turn a similar profit to the one they had anticipated.
A housing bubble bursting would hurt many people and their investments, but it is often the worst on sellers who bought during the bubble and will be forced to take a loss on their property because the prices have plummeted.
What to Do if a During a Housing Bubble
During a housing bubble you need to keep your eyes open and pay close attention to the market. While the bubble will be full of over-valued properties selling for much more than they are actually worth, there will often still be some genuine good deals available for purchase as well. So, if you are looking to grow your portfolio, try your best to avoid purchasing these overpriced properties. That way when the bubble pops your investments take the smallest hit.
Additionally, be careful with any new debts or lines of credit you obtain. While it can be tempting to refinance during this period and take advantage of the rapidly increasing equity you can get in a property, it is important to remember that you will still have to repay those debts later on.
Finally, if you have a property you have been interested in selling for a while and were waiting for the perfect moment to cash-out from, consider doing it while the prices are still high. If you wait too long to sell your property, you may miss your window to get the highest return on your investment.
Speak With a Professional
If you are worried about a housing bubble or have any other concerns regarding your real estate investments, reach out to a professional to take a look at your options. A good investor is an informed investor and that is why at LendCity we dedicate ourselves to helping you stay up to date with all of the most important mortgage and housing news. You can reach us at 519-960-0370 or you can visit us online at LendCity.ca. Alternatively, click the link below for a free strategy call to weigh your options today.