When Real Estate Bubbles Form and Burst?
How to determine whether real estate bubbles form and burst? Definitely, it is not easy to answer. But I have some suggestions to recognize it.
Market tends to slow down.
Real estate very rarely “explodes” upward in value or “crashes” downward. In other words, there are seldom any true “bubbles.” When prices go up, they tend to go up over time as each price increase builds on the last. When they turn down, many sellers convert their properties to rentals, take their homes off the market, or make other arrangements. Rather than crash, the market tends to slow down and prices slowly drift lower.
Media tends to exaggerate market.
The media tends to exaggerate the market’s direction, whether up or down. If the market has been high for awhile, expect the media to construct a “bubble” that it will say is ready to burst. If it’s been low for a time, expect the media to see “trends” of upward movement. Just because the media announces it, that doesn’t make it true.
Look at the affordability index.
Look at the affordability index for the country and your state. The National Association of Realtors (www.realtor.org) offers a national affordability index. It tells you how much house the median income family can afford.
Whenever the index is over 100, it usually means housing is still fairly affordable, no matter what the media says. When it’s below 100, watch out. Housing may have become unaffordable and the market likely will be forced to slow down. Also check newspapers, which usually report affordability indices for your state and local area.
Check interest rates.
Check interest rates. The real estate market is very interest rate sensitive. The reason is that most people get large mortgages, and interest rates affect their monthly payments. When interest rates are low or dropping, it means more people will be able to afford bigger mortgages, and consequently, more expensive houses, causing prices to rise.
When interest rates are rising, the opposite is true. The real estate market rarely turns down when interest rates are falling. It rarely maintains high levels of sales when interest rates are rising. Be aware of housing shortages. Some parts of the country, for example, Southern California, have experienced large influxes of people.
However, at the same time, housing starts have been low. The result is a housing shortage. You can usually tell when there’s a housing shortage in your area because rental rates will be going up at the same time as interest rates decline.
When interest rates decline, tenants buy and become owners, usually causing a flood of rentals that cause rental rates to drop. When rental rates stay up during low interest times, it indicates a housing shortage, which should eventually lead to increasing prices.
Watch the cycle.
Watch for the “seven-year” cycle. While a very rough gauge, real estate tends to move up, and down, in seven-year cycles.
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