Real estate bubbles occur when the prices of property, usually residential property, rapidly increase over a short period of time. This is generally caused by a surge in demand and speculation, pushing prices beyond what would typically be expected from the property’s fundamental value. This can lead to an unsustainable situation where prices can’t be supported by the market, leading to a price crash.
How does Real Estate Bubble affect the whole economy?
When property prices increase beyond their intrinsic value, it is usually caused by a combination of factors. One cause is when investors become overly optimistic about the future of the real estate market and start bidding up property prices beyond what is justified by economic fundamentals. Another cause is when there is too much easy credit available to buyers and a lack of oversight of the lending process. This can lead to buyers being encouraged to take on more debt than they can reasonably afford. This trend can lead to inflation as more money chases a limited housing supply. This can also lead to higher costs for goods and services as businesses are forced to increase their prices to cover the higher housing costs.
In addition, a real estate bubble can lead to asset bubbles. When prices rise, investors will often shift their investments to the housing market, which can lead to overinflated costs and, eventually, a crash. The value of stocks, bonds, and commodities, among other investments, may fall due to this. Because of the drop in demand, businesses may be obliged to cut back on production, which can further dampen economic activity.
As prices rise and more money is poured into the housing market, credit becomes easier to obtain, leading to a surge in consumer spending. This can lead to higher inflation as the increased demand pushes prices even higher.
How do Government policies create the Housing Market Bubble?
In the case of real estate, bureaucracy can create an environment of overregulation and red tape. This can have several effects, from stifling innovation and limiting potential buyers to building an artificial barrier to entry for potential investors. This results in a situation where buyers cannot purchase homes at a reasonable price, leading to an inflated market. This can further worsen with the government’s intrusion in real estate via launching government programmes that artificially inflate the market. For example, if a government programme is implemented that offers first-time homebuyers a tax credit, it can artificially increase demand, leading to an unsustainable rise in demand and housing prices. Another way bureaucracy can lead to a real estate bubble is by imposing excessive taxes. Local governments charging high taxes on real estate transactions can make it more expensive for average potential buyers to purchase homes, which can drive prices up.
Additionally, special interest groups, such as developers and real estate investors, often lobby the government to pass laws that benefit them, such as tax breaks and other incentives. This creates an uneven playing field providing significant leverage to one group over the other, thus forming a monopolized infrastructure. When housing prices inflate beyond the actual worth of a property, and beyond the reach of the average individual, the real estate bubble can lead to an increased disparity in society. When such an environment is created, where only the wealthy and affluent can afford homes can contribute to narrowing the economic opportunity gap and reducing social mobility.
What Happens when Real Estate bubble bursts?
When a housing bubble bursts, it often happens suddenly and without much warning. This is because prices have risen so rapidly that the market can’t sustain them, leading to an unpredictable outcome. When prices become too high, investors may become hesitant to buy properties, which can lead to an eventual crash in housing prices. This is significantly damaging for property owners because they purchase at inflated prices and may be forced to sell at a loss if the downtrend continues. Such an outcome is usually accompanied by government policies and central bank regulations that increase borrowing costs by quantitative tightening and rising interest rates. When these interest rates increase, the cost of borrowing becomes much higher, resulting in an increase in average monthly mortgage payments. In such events, even though the average home prices are down trending due to the high cost of borrowing, the average home buyer still might not be able to enter the real estate market. Because interest rates are high, eligibility criteria to qualify for loans might also become stricter because banks or lenders try to mitigate the associated risk. Thus, making it bad news for people looking to get their first mortgages.
People who have purchased property at inflated prices may find themselves incapable of producing mortgage payments, leading to foreclosure. Additionally, to keep up with their home mortgage payments, they may be forced to reduce spending and cut back on non-essentials. This cutback can dwindle consumer demand and damage the overall economy, as businesses may suffer from diminished sales and earnings. This can also lead to job losses as businesses struggle to survive in a weak economy. Likewise, people who have invested in real estate as a source to generate income and make a profit might be left with significant losses as the value of their investments suddenly drops.
The bursting of such a real estate bubble can also cause devastating economic instability at higher levels as well. When property values fall, banks can be left with large portfolios of bad loans. This can lead to a credit crunch where banks try to recover from negative investments and become reluctant to lend to businesses and individuals, leading to decreased economic activity. Overall, if the downtrend in the economy continues, this can lead to increased inflation, where the cost of food, shelter, and living reaches soaring levels. In such circumstances, it becomes hard for many consumers to make ends meet.
Fortunately, with proper awareness and careful planning impact of such devastating circumstances can be lessened. One must be aware of the signs of extreme economic conditions, such as rapidly rising prices that fundamental values can’t support. Real estate investments include their unique dangers, so it’s crucial to know what they are and spread them out as much as possible through diversification. Last but not least, monitoring the market and economic developments is vital. Doing so can safeguard homebuyers and sellers from financial hardship in the event of a sudden rise and crash in the real estate market.
