What is a Housing Bubble?
If you’re interested in the property market – or thinking of entering the market as a new homeowner or real estate investor – then you’re likely to have come across the term ‘housing bubble’.
In general, investing in property is considered a reliable, low-risk way to grow your money over time. However, like any asset class, the housing and real estate market is still subject to risk, with one of the biggest concerns in real estate investment being the existence of housing bubbles.
What is a housing bubble?
Also known as property or real-estate bubble. A housing bubble is a temporary event in which (due to various economic factors) house prices skyrocket to a point where the prices don’t reflect the fundamentals of the property.
This period – which can last for several years – is inevitably followed by a crash, where the bubble ‘bursts’ or ‘pops’ and house prices plummet as a result.
One of the most well-known housing bubbles occurred after the dot-com bubble burst and the stock market collapsed. These events happened due to investors pouring money into Internet-centric start-ups. Driving the prices up higher before stock prices dropped as investors realised the value of the stock didn’t necessarily reflect the value of the companies.
As a result, investors abandoned these stock market investments. Instead, they took to real estate, driving prices up in a housing bubble that eventually burst in the late 2000s.
How do housing bubbles happen?
Though the housing market isn’t as susceptible to ‘bubbles’ as other financial classes, the property is such a large, significant and time-consuming purchase compared to a more inexpensive asset. They still happen – and tend to last for more extended periods than other bubbles.
Like any good or service traded in the free market, house prices – and housing bubbles – are strongly influenced by supply and demand. If there is high demand for property but not enough – a.k.a. supply – to meet this demand, house prices will likely rise.
However, many factors – and often a combination of these factors – can cause house prices to rise and the housing bubble phenomenon to begin.
For example, suppose the economy is booming. In that case, people may have a higher income, allowing them to invest in and purchase property when they may not have been able to before. Moreover, more lax mortgage requirements, low-interest rates or easy access to credit can encourage people to buy homes, all of which contribute to the demand for housing.
When the demand starts to outweigh the supply – a.k.a. the number of homes or properties available to purchase – house prices begin to climb.
Speculators (risk-taking investment strategists) usually enter the market at this point. They are taking advantage of the rising house prices to ‘flip’ properties for a profit at higher prices weeks or months down the line. Further increasing the demand and making house prices soar even higher.
During this time, more properties are built to cope with the increased demand, though this takes time, so supply remains limited.
At some point, the house prices become so high that the demand begins to stagnate, or even decrease, as houses become unaffordable. Moreover, suppose the economy is lagging or has taken a hit. In that case, this can be another factor that reduces demand, as prospective homeowners have less disposable income to spend on a property.
As a result of this stagnation, speculators will pull out of the market as they realise they won’t continue taking advantage of rising house prices and demand drops even more.
Accompanying this drop in demand is an increased supply of houses built to accommodate the formerly high demand for homes. By this time, the supply well outweighs the demand and house prices plummet: the housing bubble bursts.
How do housing bubbles affect homeowners?
In addition to the obvious – housing prices increasing and making homes unaffordable for some buyers – a housing bubble on the brink of bursting, or that has already burst, can also make the homes of current homeowners difficult to afford.
Resulting in the increasing mortgage interest rates that often accompany a crash, in contrast to the often low-interest rates offered by mortgage lenders as the bubble grows. Leading to bankruptcy and foreclosure for some homeowners, while others will have to turn to their savings to keep their homes.
If you’re considering investing in real estate, remember that, although the property is regarded as a low-risk investment, the market may enter a bubble-like any other asset class. So, it’s a good idea to adequately research the market before purchasing to ensure you don’t invest in a property whose price is about to plummet.