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Whatever causes its formation, a real estate bubble is viewed as dangerous and can lead to an economic downturn.
In this post from our Q&A series, we define what a real estate bubble is.
Q: What Is a Real Estate Bubble?
A: The laws of physics state that whatever goes up must eventually go down. This is true in real estate. When the prices of properties shoot up, this drives the valuations of real property until they become unsustainably high, then they decline. Or worse, burst.
Economists agree that this is the telltale sign of real estate bubble.
According to Professor Enrique Soriano of the Ateneo de Manila University–School of Business, spotting the red flags that point to a real estate bubble will make economists’ and policy-makers’ jobs easier in identifying and preventing it. These red flags are in the areas of lending, consumer spending, and employment.
Lending
With higher housing loan programs available comes higher aspiration for home ownership. This is not dangerous in itself, but when buyers’ loan obligations increase while their income stays the same, this could mean a potential bubble forming. This is because when borrowers fail to make their monthly amortization payments due to pay cuts, illness, or layoffs, this could affect their credit standing and cause negative liquidity to banks.
Spending
When buying houses becomes very attractive, housing-loan programs abound, and property buyers bask in attractive financing plans to buy more. A vibrant real estate market can become saturated with mortgage debt, which may eventually lead to a decrease in lending and a drop in the number of homebuyers.
Employment
A vibrant labor market also typically results in increases in home sales and mortgage loans. When more people buy homes, developers build more, expecting the demand to continue indefinitely. But this is not always the case.
When job prospects plummet, professionals begin moving elsewhere in search of better jobs, causing consumer spending to decrease and the market to get flooded with unsold properties. This drives property values down, marking the true making of a real estate bubble.
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