Understanding the ‘housing bubble’ and why it’s bad news for home buyers
When house prices grow higher than its average value, the real estate market experiences a temporary yet critical period known as a “housing bubble.” Usually, compared with other asset markets, this particular sector shouldn’t be subject to pricing bubbles because of two fixed factors: the huge carrying cost of owning and maintaining a home, and the large transaction cost of purchasing a property.
While some aren’t really convinced that this market phenomenon exists, many experts agree that most periods of housing price bubbles are driven by an increase in demand. However, the most important question here is, what are actually the specific causes of such increase in demand?
The combination of a number of variables can easily cause a housing market bubble. Under the right circumstances and timely specific buyer behaviors, the resulting effects can create the perfect formula, encouraging risky decisions and speculative behaviors by several participants: investors, builders, buyers, lenders, and borrowers.
Observe when the economy is at its best and people can usually turn to more disposable income to invest on an asset, particularly housing. A healthy economy means an optimistic credit growth, encouraging buyers to carelessly take on debt. Taking advantage of the currently positive market and economic standing, consumers can usually enjoy low interest rates and loose borrowing standards. These factors can overall promote offhand speculations and risky behaviors.
The increase in investors, that are most of the time, “unfit” homeowners is the byproduct of all these factors working together to produce one final result that could suddenly disrupt the market: a dramatic rise in home prices, effectively paralyzing homebuyers to afford what they previously could.