What Is A Real Estate Bubble And What Happens When It Pops?

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I am absolutely in love with learning and sharing all things real estate. I’m an agent for Jacaranda Real Estate In Harare, Zimbabwe. This blog will be the ultimate resource for all things real estate so subscribe and stay tuned.

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If history has taught us anything about the field of real estate, it is this; there is nothing more dangerous to a real estate investor (any home buyer) and economy than the existence of a real estate bubble or more specifically; the effects of a real estate bubble that has just burst.

This post will take you through a comprehensive guide of everything you should ask and know concerning real estate bubbles and I’ll begin with this…

What Is Real Estate Bubble?

 

A real estate bubble occurs in a situation of 3 expected economic predictions for the real estate market.

These 3 predictions are the following:

  1. That the real estate market will boom.
  2. That the real estate market will froth.
  3. That the real estate market will pop.

1. That the real estate market will boom.

 

The boom period consists of a rapid unpredictable rise in real estate prices across the board (sales and rental prices) because of speculations.

The boom period is expected to be unsustainable and inevitably drop. where prices will begin to decline.

2. That the real estate market will froth.

 

The froth period is the period of an expected decline in home prices across the board. the froth period is the relatable manifestation of “what goes up, can’t go up forever and must come down.”

The froth period is a period of lowering prices that do not unreasonably disrupt the market because though the drop was expected; it is expected to stabilize at a higher level than it was before.

3. That the real estate market will pop.

 

The pop period is the occurrence of a market crash that affects the real estate market; where the value of money and real estate has dropped to such degrees that the market as a whole has become unstable and unpredictable.

 The pop period is where the real estate market experiences the most damaging effects for the industry that I will cover below.

What Is A Housing Market Crash?

 

This post will primarily focus on how the consequences of a real estate bubble popping but to fully understand this, I will give a brief explanation of what a market crash is.

This is because, though all assets can experience a “bubble” state like the “Dot-com bubble” of the 1990s; a real estate bubble is one of the few bubbles that can lead to a significant overall market crash – This is because real estate is a credit-fuelled industry.

 Most bubbles, like the aforementioned “dot-com bubble” don’t have huge rippling repercussions that affect everyone in the market because the people who can participate/live in the bubble are relatively few; rich investors with the means and influence to invest in the bubble.

A real estate bubble is not like this as the participants who live in the bubble are both large rich investing entities (companies and real estate investors) but also many people from average households who take out loans and mortgages to buy homes.

The wealth involves and at risk in a real estate bubble is massive and is all intertwined through a few banks and mortgage brokers. When they crash, it all crashes.

What Are The Effects Of A Real Estate Bubble?

 

Because the “bubble” state is accumulatively the 3 stages of boom, froth, and pop; there are appropriately 3 different stages of effects that occur in conjunction with each stage.  

During Stage 1-  The Real Estate Boom.

 

1. A sharp rise in the prices and value of real-estate (rentals and sales) that is not proportionately supported by economic fundamentals.

 

The price rise is started and driven by mass speculation of reputable sources who encourage others to demand more real estate to invest in; which pushes demand and price.

2. Increased popularity in investment from companies (early adopters) and media coverage of the real estate.

 

Large entities are typically the first to take advantage and invest in the bubble; they have access to the intellectual and financial sources necessary to invest in real estate to such a degree that it creates positive expectation and desire that drives the general public to invest in real estate

Thus further increasing demand, and further increasing the price of real estate assets.

3. Increased popularity in investment from the general public.

 

The general public makes up the vast majority and late adopters of all bubbles including the real estate bubble. They are encouraged to start investing in real estate at a higher risk than larger entities because they see these entities investing in real estate with the expectation of great returns on their investment.

4. A decline in lending standards from gatekeepers.

 

Banks and mortgage brokers are not immune to the frenzy caused by the mass purchases of real estate. Where normally individuals are thoroughly vetted of their capabilities to invest in property they can justifiably afford; the bubble mentality inflates the value peoples’ current real estate assets and thus allows them to invest above their means.

This coupled with the fact that because it is seen as if the current prices of real estate a discounted as they are expected to keep rising; it creates an environment of providing lenient loans that people cannot afford.  

5. An increase in “newly founded” theories to explain the real estate price rises and values.

 

Where there is no justifiable reason for something to happen, people create their reasons. It is common for many favorable publications and theories to be founded around justifiably proving the narrative of the price rises.

During Stage 2 – The Real Estate Froth.

 

1. Prices are expectedly beginning to drop in real estate (rentals and sales).

 

“What goes up, must come down.” The froth is that period of coming down. The main difference between the price decline found during the froth and that found during the pop (crash) is this;

The decline during froth is expected to stabilize at a point that is historically higher than where real estate assets were before.  

2. Some Individuals are selling their inventory as they are expecting the wave to end and want to make a profit while they can.

 

large entities and individuals who invested in real estate early into the boom will likely sell their assets not and reap massive returns on their investments. It is riskier for them to hold the assets now as they are losing value than to sell them at an already huge gain.

3. Some individuals are holding or still buying real estate with the expectation that the price drop is temporary.

 

For individuals and entities that invested into real estate late into the boom, they are more prone to hold their assets and potentially purchase more because they expect the opportunity of prices to rise to still be viable and their risk of loss is significantly less than early adopters because they have not gained as much.

4. Lending standards are still loose but are starting to tighten up again.

 

Banks and mortgage brokers will see the froth trends from a bird’s eye view and are unlikely to issue loans for asset purchases as liberally as before because they can see how the market is becoming far riskier.

5. “Newly founded” theories are being proven unsustainable and baseless.

 

The previously mentioned justifications of why the values and prices and real estate assets are now being tested and in many cases; are being proven wrong as prices fall in environments that the justifications state prices would rise in.

Remember, bubbles are caused by unpredictable speculations not measurable and repeatable laws.

During Stage 3 – The  Real Estate Pop.

 

1. Prices have dropped to dangerous and unexpected levels for real estate.

 

Real estate values and prices have dropped far below expectations.

Expected price drops are any values above the historical point of initial price rise; though it is usually much higher than this as most would not expect a huge drop in price and value.

An unexpected and dangerous price drop occurs when real estate prices and values drop below the historical origin.

2. Many are looking to sell to get out of unfavorable positions and contractual obligations but supply is greater than demand.

 

Many are realizing that they are in a position of great risk of being in enormous debt with assets that have no relative value because of the crash. Properties are worth less than what they were bought for and people owe more than they can get from them.

Speculation is now working negatively as more people expect prices to continually fall which causes more people to want to sell and less to buy; thus causing prices to lower even more.

3. Lending institutions are at high risk of collapse and will barely be issuing out loans.

Lending institutions are now at a huge risk of collapsing because the vast majority of their financing that they provided to entities to purchase real estate has a significantly low chance of being paid back.

Individuals owe money to the bank and mortgage brokers that they can’t pay back and the assets the bank would normally take back as collateral have significantly less value than the amounts the banks and mortgage companies loaned out.

The banks are at risk of going under because they have no money.

4. The economy as a whole suffers.

 

I mentioned above that all assets can have theoretical “bubble” states but that real estate is one of the few industries which have a bubble that can directly disrupt the stability of an entire states’ market.

This is because when real estate bubbles burst, banks and lending industries risk crashing with them (as mentioned in the above point), and when banks go under; the entire economy as a whole, risks crashing.

When banks lend money to individuals, the money they lent out is drawn from a pool of funds supplied by everything in the industry. When banks and mortgage companies lend out money for real estate investment; that money is provided through the deposits of tech companies, grocery stores, consultation firms, and all other companies that contribute to the economy.

And when banks go under, the money lost is not just from real estate investors but from all those other companies as well. This causes the market as a whole to crash just because of a real estate bubble.

What Causes A Real Estate Bubble?

 

As stated above, real estate bubbles like all bubbles are the result of mass synchronized speculation of people of influence in the sharp rise of an asset’s value without any supportive proof from the fundamentals of economics (demand and supply).

The fact of the matter is this, bubbles are often impossible or extremely difficult to identify until the bubble pops and the consequences and damage take effect.

Those who say that bubbles cannot be expectedly predicted and prevented; resolve to say that governments and lending institutions are the entities who are meant to be responsible for dealing with the damages of the aftermath

Others state that through real estate indicators as done by economist Robert Shiller; real estate bubbles can be predicted and through government influence and lending facility financing restrictions and control – the bubbles can be avoided or deflated out of existence without causing mass damage and panic.

Housing market indicators have been used in specific cases to prove the existence of bubbles before they burst but whether this is out of luck or laws is unproven. If you want to learn about the specific real estate indicators used to present the state of the housing market and predict bubbles – you can find my post on it (HERE).

What is agreed on is this, the government and lending facilities are the only entities who can be relied on; either to clean up the mess or to prevent it.

How Long Does A Real Estate Crash Last?

 

The difficulty in creating a timeline for any real estate bubble is part and parcel of why predicting a bubble is so difficult.

Just because the prices of real estate are rising; does not mean a bubble has started – and just because prices are dropping does not mean the bubble is about to burst.

When timelines are made, such as the crash of 2008; they are identifying the period where the bubble burst and the economy is in turmoil because price levels have dropped to dangerous levels.

To create a periodic timeline requires the identification of when prices were rising unreasonably but because unreasonable price rises are justified by continuous streams of ‘new-age’ theories; this is almost impossible.

Should You Invest In Real Estate During A Bubble?

 

 It is undeniable to dispute the fact that real estate bubbles are as much; environments of great potential as they are environments of great risk.

If you have the means, you should invest in real estate during a real estate bubble; if you know that you are investing at the right time. Wherein lies the issue.

Because bubbles are based, live, and thrive or die through speculation the success or failure of an individual’s investment in said real estate depends on when they invest concerning the tide of speculation.

Invest in real estate during the boom; the beginning of the speculation wave; when prices are just starting to rise and rise to large levels; an investor stands to gain enormous returns on their investment.

Invest in real estate during the froth; where prices are declining there is significantly more risk but there is still potential to earn a good return. Remember, a froth is not the pop or necessarily a period of economic turmoil.

During the froth, prices are declining but are doing so within prediction and within the expectation that they will only fall to stabilize or rise (to a smaller degree) to stabilize. For individuals who expect the fall to symbolize an expected rise and stabilization; there is still an opportunity to invest and gain.  

The underlying issue that should always be considered is this; speculation is rarely ever verifiable by fixed constants. That is to say, it’s hard to invest effectively during the many stages of a bubble because of the following 2 reasons:

  1. You don’t know if you’re in a bubble.
  2. You don’t know what stage in the bubble you’re in.

But that doesn’t take away the fact that if you can handle the risk factor or through some secret ways you know how to read the real estate bubble; the bubble is a huge opportunity for great gain.

Conclusion.

 

Real estate bubbles live in the environment of “the greater the risk the greater the opportunity.” They are these instances of unpredictable and unknowable environments that allow investors to equally make huge returns and huge losses through what is mostly the luck of the dice (speculation).

We always see real estate as one of the greatest fields of investment where valuations appreciate year after year but prices and values can’t go up forever and if we expect them to, we might just find ourselves in a bubble about to burst.

 

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I am absolutely in love with learning and sharing all things real estate. I’m an agent for Jacaranda Real Estate In Harare, Zimbabwe. This blog will be the ultimate resource for all things real estate so subscribe and stay tuned.