Is There a Housing Bubble? If So What Does a Burst Mean?
"Is there a housing bubble?"
We hear this question a lot from both buyers and sellers. To understand the answer to that question, we first need to understand what a housing bubble is. According to Investopedia, a housing bubble is defined as:
“A housing bubble, or real estate bubble, is a run-up in housing prices fueled by demand, speculation, and exuberant spending to the point of collapse. Housing bubbles usually start with an increase in demand, in the face of limited supply, which takes a relatively extended period to replenish and increase. Real estate speculators pour money into the market, further driving up demand. At some point, demand decreases or stagnates at the same time supply increases, resulting in a sharp drop in prices—and the bubble bursts.”
Based on that definition let's take a look at the current market and how it relates to that definition:
- Run up in the housing prices field by demand? Check
- Exuberant spending to the point of collapse? Check
- Increase in demand in the face of limited supply? Check
- Speculators pouring money into the market further driving up demand? Check
So going by these criteria, which I think are pretty accurate in my opinion, we are indeed in a housing bubble.
So what happens when it bursts?
The thing about this is that Americans really only relate to one bubble bursting, the 2008 bubble when in reality this cycle has been happening for many many years in the real estate industry.
When a housing bubble bursts the demand for housing drops drastically. This creates an oversupply of inventory as suddenly there aren't enough buyers for the newly increased supply of homes available. The market will shift rapidly as buyers are able to make competitive offers on homes rather than ending up in a bidding war as had been recently occurring.
What happens to my home's value if this happens?
While there is a lot of concern about home values dropping as drastically as they did in 2008, my opinion is that if and when the bubble bursts we will see a normalization of pricing in the market, not a crash.
So what's the difference? The crash of 2008 was caused by a combination of predatory lending practices combined with the willingness of those in the financial markets being willing to buy mortgage-backed securities simply on the promise that they were based on quality loans without actually doing the work to make sure of that.
This means that the majority of homeowners who defaulted on their mortgages in this period had very little or no money invested in the purchase of their homes, literally 100% financing was the norm, not the exception.
The difference between now and then is staggering as far as the quality of loans and qualification requirements to buy a home. If you're reading this and you have purchased or refinanced a home between now and then you know exactly what I mean.
These days you have to QUALIFY to buy a home and most homeowners have invested heavily in the purchase of their homes.
This means that should we face a market pricing normalization, while some percentage of home values will be lost, it will most likely not be the 35%-50% losses in equity that homeowners experienced in 2008. The reason for this is simple as I explained: homeowners have more skin in the game and therefore more to lose and will likely not start walking away from their homes in droves simply to avoid paying the mortgage that they couldn't afford in the first place.
When this happened in 2008, it started a market pricing free fall that created the immense equity losses that people experienced at that time. What I expect during a pricing normalization is that homeowners will see a 10%-20% drop in equity value depending on their market and their area. As before the places that went up the highest the fastest, for example, Corona or Riverside California will see some of the most dramatic pricing drops.
What should you as a homeowner do?
My advice as a homeowner and real estate professional is that if this happens, you should stay put in your home. We know historically prices are cyclical and since the 70s home prices have continued to appreciate over the long term, so if you love your home and you get to keep it, do so. If you have to move in a declining market please avoid the trap of “oh my house was worth this in 2022.”
None of us can change the past. All we can do is live today. If you would like to be that person with a story of how you timed the market and sold at the top give us a call at (714) 406-1414 for a free market analysis of your home.