The term ‘housing bubble’ is enough to give anyone savvy about real estate cold feet; however, even though property values are increasing, demand is increasing, and supply is decreasing (circumstances presented at the start of the last bubble), there are key differences that keep this scenario from being a bubble and instead just make it a great time to buy and sell.
What’s a Housing Bubble? From a financial standpoint, a bubble occurs as a result of extreme fluxes in terms of demand and supply. Typically these kinds of things don’t happen in housing markets because real estate involves large, costly commodity transactions minimizing the likelihood of having extreme supply / demand issues. So, how does a housing bubble work?
- Start with high demand of a commodity that can’t satisfy the demand in a timely manner. In the housing market, this would be if there were many people looking to buy houses but that there weren’t enough houses available to please buyers.
- Factor in the time it takes to satisfy the demand. Usually when this happens, prices increase; the problem with this is that the price of the home can exceed the home’s actual value in a non-inflated market.
- Enter spectators who increase pressure on the bubble. Supply and demand is already at an imbalance, and investors who flip real estate to net quick and easy profits disrupt things even further as their activities ultimately result in driving up prices as well as demand.
- Demand ebbs as supply advances. At some point in this process, the reality that “what goes up must come down” kicks in and there are lots of overpriced houses available and no one to want them.
Two of the key contributors to the Jumanji-like demand stampede that occurred during the last bubble were:
- Loose-lending practices: During the bubble, many lending underwriters loosened their criteria for issuing loans so much that the housing market couldn’t keep up with the number of eager buyers ready to purchase a home.
- Super-low interest rates: Historically low interest rates also contributed to demand; many purchased or considered purchasing real estate who were not even (originally) in the buyer’s market due to the promise of locking in a low interest rate.
This is essentially what happened in the last housing bubble, which is why with property values climbing (with great humility) back to a more satisfactory place (particularly for homeowners), there’s a growing dread that the recent upturn of events could also be a bubble; however, experts on the matter concur that it’s not due to some important differences.
Why This is Not a Bubble
There are actually several differences between then and now in terms of the housing market and getting into another bubble. A major difference is now we know better, and no one wants to recreate the mess and subsequent clean-up merited by the last housing bubble burst. Aside from, “We’ve learned our lesson,” here are some other more concrete reasons we aren’t getting into another bubble:
- Lenders are tightening up somewhat. Lenders are getting more discerning, which has more to do with avoiding loan defaults than anything else; however, it helps keep demand more appropriately paced than it was in the early 2000s. Though interest rates are low and are still low, the frenzy that their reduction inspired is not as problematic.
- The appreciation of home values is defensible. While the circumstances of real estate value increases are similar to past appreciation, there is a key difference in that today’s appreciation prices are not artificial due to demand. They are higher –yes, but they are more comparable to 2001 values, which is 30% lower than the overly-inflated 2005 high values.
- Speculative flipping has all but ceased. While there are still real estate investors engaged in flipping, the volume and intensity of the flipping investors has decreased substantially.
The reason that what is happening in today’s market harkens to the housing bubble of yesteryear is that demand has increased enough that there’s a limited supply of desirable homes; additionally, home values have increased over the past year. The distinction is –as noted—that these value increases are not artificial, and the demand is not such that there is a frenzy to either produce homes or to inflate their value to satisfy a competitive marketplace. Further, lenders are putting their feet down on irresponsible lending practices, which keeps demand at bay.
For buyers and sellers in today’s market, what all of this means is that –as of right now, it’s not a housing market; it’s a fair market. Home values are becoming increasingly accurate, so seller prices are fair (or they should be). Sellers who overpaid at the height of the bubble may be at risk of losing some, but the important thing is that things are balancing out.
The advantage to buyers is they can expect to get what they pay for in a property, and when they go to sell one day, they can hope to make money (as real estate appreciates in value) provided the area and the property are still in marketable shape.
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