What is the real estate bubble?

with:
1 Comment



A real estate bubble is a sudden and feverish increase in real estate prices of an area, mostly caused by demand and speculation. Real estate bubbles usually form with an increase in demand when the supply is limited, and the limited supply takes a long time to replenish and increase. At such a time, a number of people speculate and their speculations affect the market, which drives the demand further.

For example, announcement of the construction of a new airport in Shamshabad (Hyderabad) led to heavy media speculation. This speculation resulted in people feverishly buying and selling land around the area, and the property prices shooting up. This surge dissuaded developers from investing, and the prices had to be corrected to encourage development.

In many cases, it takes a long time for the price correction to take place, and a bubble can either form while the area is developing or before the development starts.

But, is this development sustainable?
At some point of time, demand decreases or stagnates, prices drop, and the bubble bursts.

What causes a real estate bubble?

  • An sudden and unprecedented upturn in general economic activity and prosperity that puts more disposable income in consumers’ pockets and encourages home ownership
  • The paucity of available land as a result of poor infrastructure drives prices in the most sought-after areas
  • Restrictive town panning rules that stymie development and increase prices
  • Speculative and risky behaviour by home buyers and property investors fuelled by unrealistic and unsustainable home price appreciation estimates

What causes the bubble to burst?

The bubble bursts when excessive risk-taking permeates the real estate system. This happens while the supply of real estate is still increasing. In other words, demand decreases while supply increases, resulting in a fall in prices.

This pervasiveness of risk throughout the system is triggered by losses suffered by homeowners, lenders, and property investors. Those losses could be triggered by a number of things, including:

  • An increase in interest rates that puts homeownership out of reach for some buyers and, in some instances, makes the home a person currently owns unaffordable, leading to default and foreclosure, which eventually adds to supply.
  • Demand is exhausted, bringing supply and demand into equilibrium and slowing the rapid pace of home price appreciation that some homeowners, particularly speculators, count on to make their purchases affordable or profitable. When rapid price appreciation stagnates, those who count on it to afford their homes long term might lose their homes, bringing more supply to the market.

The bottom line is that when real estate prices reach a point where people cannot afford, there are no sales for over a year, developers correct their prices to make real estate affordable, then the bubble bursts.

How to identify a real estate bubble?

A real estate bubble is usually identified in retrospect. But, if we pay close attention, we’ll be able to recognise certain indicators.

  • A sudden and illogical hike in the property prices of a certain area is enough to raise a red flag.
  • Property prices have the propensity of rising. That said, one should always look at the reason behind the said rise. There are areas that have developed and a price rise in these areas is quite justified. However, a price rise based on an announcement or speculation should be considered warily.
  • Every city has certain localities that will always have steep property prices. But, if the prices of properties in a certain area are high because of proposed future plans, then one should avoid investing these areas.
  • One should always look for available/vacant flats in properties to ascertain the existence of a real estate bubble. This means, the developer had raised the prices to an extent where it stopped being feasible for the general populace to invest in his project.

These are indicators of an impending market correction in the near future and you would benefit by waiting for the prices to drop.