Housing Bubble

Updated on January 29, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Housing Bubble?

A housing bubble is a duration in which the cost of houses and other real estate properties increases dramatically at the local or global level. The prices can continue to grow at any time until the supply eventually catches up. The trend can end with a sudden drop in house prices, causing the bubble to burst.

Real estate prices can sharply increase due to greater demand for housing than supply and speculative investments. Other factors that can raise prices are high liquidity and unsupervised lending regulations. A housing market crash is mostly temporary but can extend for long periods, leading to the bubble contraction and negatively impacting the economy for the short term.

What is Housing Bubble

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Key Takeaways

  • A housing bubble meaning describes a period when the price of houses and other real estate properties rises unexpectedly on a local or global scale.
  • It occurs due to a rise in housing demand, loose lending requirements, uncontrolled market, and speculation, all of which drive up real estate values.
  • It is only transitory and can result in a dramatic decline in property values known as a housing bubble burst but can have a short-term detrimental impact on the economy.
  • The most significant real estate bubble in modern history was of the U.S. Canada and Australia are also experiencing housing prices crises.

Understanding Housing Bubble

The housing bubble definition implies overpricing of real estate and market speculation. It is relatively rare compared to bubbles in other markets because housing is expensive. But it can still occur at any time, from short periods to a few years. Furthermore, it can harm the regional and international economy, resulting in financial crises and housing market instability.

After reaching a point where prices become unsustainable due to economic slowdown, rising interest rates, or borrowers’ inability to repay mortgages, demand decreases, and prices fall. Let us look at the factors that create the bubble:

Housing Bubble Factors

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#1 – Demand For Housing

The real estate bubble begins when the demand for housing exceeds the supply in the market. It can be due to a population rise or a booming economy where people can afford homes. Lower interest rates and relaxed lending guidelines can also contribute to growth in demand. Thus, housing prices increase based on the law of supply and demandLaw Of Supply And DemandThe law of supply and demand refers to one of the core concepts in economics explaining the relationship between demand, supply, and price of products and services. It integrates the concepts of the law of demand and the law of supply.read more.

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The demand for real estate properties increases the investor appetite for real estate. Housing prices rise as a result of speculatorsSpeculatorsA speculator is an individual or financial institution that places short-term bets on securities based on speculations. For example, rather than focusing on the long-term growth prospects of a particular company, they would take calculated risks on a stock with the potential of yielding a higher return.read more actively purchasing properties. Eventually, real estate companies build more homes to cater to the increase in demand. The limited housing supply takes a substantial time to catch up or surpass the growing demand. But once it happens, the prices start to decline, and the housing bubble bursts.

#2 – Large Scale Lending

When investors are overly eager to profit from the market, this might have unintended consequences, such as predatory lendingPredatory LendingPredatory lending is the aggressive approach followed by the lender to entice borrowers to take a loan which carries a high fee, high-interest rate, unnecessary penalties and other such aggressive credit terms.read more. Banks and financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more use this practice to lend to those who cannot afford mortgages, with extremely unfair terms. The lenders might even know that the borrower cannot repay the mortgage. The lack of awareness on the borrower’s part can also encourage predatory lending. It can create a spike in house owners that eventually culminates in the real estate bubble.

#3 – Poor Regulations

The lenient mortgage lending restrictions can also allow most people to obtain home loans. Furthermore, the lower home buying taxes and an unregulated housing market contribute to the real estate bubble. In such cases, buyers opt to buy homes rather than rent them.

More people, particularly foreign investors, purchase second or third houses to rent out or flip for profit. Flipping homes involves buying homes at a lower price, waiting for some time, and then selling them at a higher price. The profit marginsProfit MarginsProfit Margin is a metric that the management, financial analysts, & investors use to measure the profitability of a business relative to its sales. It is determined as the ratio of Generated Profit Amount to the Generated Revenue Amount. read more are sizeable during a bubble. The real assetReal AssetReal Assets are tangible assets that have an inherent value due to their physical attributes. These assets include metals, commodities, land, and factory, building, and infrastructure assets. read more value rises until it reaches economic affordability measures such as income and price-to-rent ratios.

#4 – Easy Buying Options

Desirable mortgage plans, lower interest rates, and reasonable installments lure more people to purchase homes. Sometimes a particular section of the population can also suddenly enter the housing market due to urbanization.

Housing Bubble Of 2008 (US)

The 2008 real estate bubble in the United States is one of the most infamous bubbles in history. More people were acquiring loans they could not afford, resulting in increased housing demand, subprime mortgage crisisSubprime Mortgage CrisisA subprime mortgage is a loan against property offered to borrowers with a weak or no credit history. Since the risk of recovering is high, the interest rate charged on such mortgages is higher so that the lender can recover a maximum amount at the beginning of the loan.read more, and speculative trading.

The real estate bubble began against the backdrop of a booming economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more and stock market in the U.S. It caused people’s faith in the housing market to reach new heights, which increased mortgage financing. There were also numerous instances of home flipping. It was possible since the housing price began a steeply rising trajectory that was generally unstable over the long term.

In general, the U.S. housing bubble was fueled by rising house prices and the number of people buying homes. Other reasons were government measures, such as lowering interest rates and loosening lending requirements in 2005-2006 that encouraged homeownership. Housing prices were highest in 2006. But once these policies ended, home prices started to fall in the same year, causing the bubble to burst and the market to crash in 2007. The most significant drop in U.S. housing prices was in 2012. However, according to the Case-Shiller home price index, the nation reported the historical price decline in 2008.

The issue with the bubble was that many parties believed they could make money in the market. As a result, everyone from individuals to banks, financial institutions, and other corporate entities began to invest in the housing market. Thus, there was a lot of cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more, which drove up home prices. However, all these parties with a history of excellent success suffered when the market crashed.

Impact

The aftermath of this housing bubble burst was a lingering credit crisis that contributed immensely to the Great Recession in the U.S. It caused an enormous instability of the economy and widespread losses in associated markets.

Housing Bubble Impact

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Similarly, the bubble affected real estate, mortgage markets, builders, and home supply retail businesses. The housing market crash forced the government to take corrective measures like the bailoutBailoutA bailout refers to the prolonged financial support offered by the government or other financially stable organization to a business in the form of equity, cash, or loan to help it overcome certain losses and stay afloat in the market.read more of the U.S. housing market for struggling property owners.

Housing Bubble In Canada

The Canadian housing bubble started in 1996 and has been significantly rising ever since. This bubble was most significant when housing prices rose by more than 300% between 2003 and 2008. The last noted bubble burst in the Canadian housing market was in 1990. Currently, the housing prices are more than the adjusted prices during the 1990 burst.

The surge in commodity prices in 2000 was one of the reasons contributing to the real estate bubble. It was fueled by rising demand from upper- and middle-class residents in China and the United States, which prompted rural-to-urban migration. It has also been a crucial factor in keeping the bubble in Canada intact to date.

Large-scale renting by immigrants and the inflow of foreign money into the economy are other reasons that caused tension in the housing market. In addition, there were government policies that favored mortgage lenders and extremely cheap interest rates that allowed customers to buy more, further aggravating the situation. Similarly, real estate prices have been soaring in Canada, hinting at a real estate bubble. It can be attributed to increased dwellings in remote cities due to the COVID-19 pandemic, resulting in more home purchases.

The bubble in Canada is an ongoing problem. But there have been efforts to slow it down to avoid a bubble burst. Reducing the bubble rate of growth (or even reversing it slowly) would also make homes more affordable, especially for first-time homebuyers. Some of the policies adopted by the government to curb the bubble in Canada include taxing foreign property buyers more than citizens, heavily taxing speculators, and implementing rent controlRent ControlRent control is a legislative practice allowing governments to determine maximum limits and annual growth in rental rates in certain cities and states. Once enacted, the rule restricts landlords from charging or raising rent or lease rates past a certain percentage.read more measures. Individual provinces in Canada have also made individualized efforts to end the crisis.

Housing Bubble In Australia

There has been a lot of postulation about the housing bubble in Australia since 2010. The housing prices have been steadily rising and are now overpriced. Various factors are blamed for the event, including the government restrictions on the land supply, increasing the demand for housing in general. Speculators are prompted to make money from the rising prices. It causes the bubble to grow at a faster pace.

The interest rates are believed to have hit rock bottom, decreasing the average home loan rate. Since more people have started to work from home amid the COVID-19 pandemic, personal savings have improved, increasing buying powerBuying PowerBuying power in trading refers to the funds available in the trading account to trade stocks, cryptocurrencies, options, etc. It includes the money held in the brokerage account and the margin available. A change can greatly affect security prices in the financial market in different forms, such as discount rates.read more.

Several national and international surveys in various parts of Australia have found that the property price is much higher than historical averages. It supports the notion of a present real estate bubble in Australia. It has even resulted in a government inquiry into the issue. Many stipulations about bringing more lending restrictions for banks are going on as it encourages Australian citizens to buy houses.

Housing Bubble In China

In 2005, China experienced a real estate bubble that led to more middle-income citizens being unable to afford homes, particularly in metropolitan areas. Rather than a burst, China’s housing bubble started deflating in 2011, which was partly responsible for the country’s declining economy in 2013. During the bubble, property prices tripled compared to historical averages.

Policies enacted by the government and Chinese cultural norms have had a massive impact on worsening the problem. During 2010-2013, housing prices significantly increased due to urbanization, rising incomes, and an improving economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. Currently, housing prices in China have leveled off.

Frequently Asked Questions (FAQs)

What does the housing bubble mean?

A housing bubble happens when the price of homes and real estate properties experiences a hike as the demand surpasses supply. These bubbles are temporary but can have adverse effects on the economy. The trend, however, can come to an end with a sharp drop in property prices, known as a bubble burst.

What causes a housing bubble?

It can happen due to a variety of reasons like an increased housing demand, low-interest rates, flexible mortgage options, an unmonitored housing market, low taxes, high liquidity, speculative investments, etc. A combination of these factors can work towards a potential housing prices crash.

What happens when the housing bubble bursts?

When the bubble finally pops, the housing prices suddenly start to decline. While it can create severe economic problems, home sellers suffer the most as they suddenly find their houses worth less than the actual price. It can potentially trigger a credit crisis, affecting real estate, mortgage markets, home builders, and home supply retailers.

This has been a guide to a housing bubble and its meaning. Here we discuss the housing bubble in the United States, Canada, Australia, and China, along with its factors and impact. You may learn more about financing from the following articles –