As in the stock market, people identify and accept the risk of a fall in prices from time to time. Just like that, many people who buy houses do not really focus on whether the value of their property can ever decrease by all that much.
As per the previous data collected by the experts, it can be observed that the housing market has never been affected by the price bubbles as compared to the other assets. However, sometimes the housing market goes through a period of irrational exuberance and faces a rise in prices before falling back in line.
In the following article we are going to discuss the housing crash, housing price bubbles, triggers that make the bubble burst, is the housing market going to crash, and much more.
What do you mean by Housing Bubble?
Before getting into the cause and effects of the housing market crash, first, let’s discuss what housing bubbles are and what makes them go up.
Basically, the housing bubble is a high jump in housing prices due to certain factors.
Generally, These housing bubbles begin with the jump in demand for houses, despite a limited inventory available.
Housing bubbles give a direct impact on the real estate industries, but also affect the house owners and their finances. These housing bubbles can force people to find ways to keep their mortgage payments when the time will turn and get tough.
In the equity, market bubbles happen more frequently. According to the international monetary fund (IMF), the housing bubbles can persist for a long time and can last for many years.
Causes of Housing Market Crash or Bubbles:
Just like goods and services, the prices of housing are driven by the law of supply and demand. When demand increases supply decreases, vice-versa then the prices increase.
Don’t have many ideas about the law of supply and demand? Well, laws of supply and demand play an important role in price hikes or depreciation. Out of for measure rules, the rules responsible for the price hike are:
- When the supply decrease and demand stays the same, then the price will go up
- When the supply stays the same but demands increase, the price will go up
As prices rise when demand tends to outer space supply trends When there is no natural disaster, the supply of homes decreases. It can also be slowed by increases in demand because it takes time to build and fix up a house. So, if the demand increases suddenly, prices will rise exponentially.
Causes of increase in demand for houses:
Following are some of the reasons that cause an increase in demand for the housing market:
- The rise in general economic activities
- Increase in the income of the people
- An increase in the population or demographic segment
- Low level of interest rates
- Innovation of new mortgage products
- Easy access to credit
- Lower underwriting standards
- High structured mortgage-back securities
- Lack of financial literacy
- Speculative behavior
- Increase in home flipping
- Affordability
- Cost of renting
All the above reasons are combined with each other to cause a housing market crash or bubble to take off.
Forces that burst the housing market bubble:
Excessive risk-taking factors help to burst the housing market bubble. As throughout the housing system prices do not reflect anything which is close to fundamentals.
The bust of a bubble happens when the supply of housing increases in response to the previous demand spike. In simple words, when the supply increases demand the product decreases.
This bubble bursting system was triggered by the suffering of mortgage investors, homeowners, mortgage lenders, and property investors. These things can be more understood by the below things:
- Increases in the interest rates make the house unaffordable. This often leads to foreclosure and default, which adds to the current house supply available in the market.
- The downturn in economic activities eventually leads to less income, and job loss, thereby decreasing the demand for housing and creating a recession.
- Bring demand and supply into equilibrium and slow the pace of home prices.
What is mean reversion?
Mean reversion or the reversion to the mean is a theory implying the prices of assets and historical returns that move towards the long-term mean, which is based on the economy, industry, or average return within a set of data.
When the deviation of the mean is higher the probability of the next movement of asset also becomes higher and this eventually would decrease or increase the momentum of stock would have a less extreme event that doesnt cause as much fluctuation.
Price Appreciation estimates:
Many home buyers only use recent house price performance as benchmarks for what they can expect over the next few years. People take excessive risks based on their unrealistic estimates. This is usually associated with the choice of mortgage, size, and costs of the house the customer is purchasing.
These mortgage products are marketed for consumers and designed for short-term loans.
People choose mortgage loans because they expect that they will be able to refinance that mortgage within several years, and they will be able to do so because of the equity they will receive from their property.
Taking risk is not bad, in fact, sometimes it is necessary and advisable to make good decisions to take a high risk but understanding the cause and effects of risk is very important.
Key takeaways:
- Housing bubbles pop up for some specific period of months or years characterized by an increase in demand and a decrease in supply and a rise in the prices above the fundamentals.
- These bubbles can be caused by a variety of factors like a rise in low-interest rates, economic prosperity, high mortgage product offering, and eBay access to credit.
- Forces that make the housing crash include a downturn in the economy.
- Bubbles follow the law of demand which is an increase in demand, decrease in supply, or vice-versa.
The Bottom Line:
The simple and important principle of finance is to mean reversion. Generally in the property market housing bubbles are not a frequent thing, but these housing bubbles lead to a housing market crash.
The bubbling of housing cannot be predicted with the very recent dataset, instead, the long-term average provides a good prediction of housing prices that will eventually end up in a period of appreciation or fall in the prices.
If you want to play safely at the time of market bubbles read the above article carefully mention what you found most helpful in the comment section below.
