Areal-estate bubble orproperty bubble (orhousing bubble forresidential markets) is a type ofeconomic bubble that occurs periodically in local or globalreal estate markets, and it typically follows a land boom or reduced interest rates.[1] A land boom is a rapid increase in themarket price ofreal property, such as housing, until prices reach unsustainable levels and then decline. Market conditions during the run-up to a crash are sometimes characterized as "frothy." The questions of whether real estate bubbles can be identified and prevented, and whether they have broadermacroeconomic significance, are answered differently by differentschools of economic thought, as detailed below.[1]
Bubbles in housing markets have often been more severe thanstock market bubbles. Historically,equity price busts occur on average every 13 years, last for 2.5 years, and result in about a 4 percent loss inGDP. Housing price busts are less frequent, but last nearly twice as long and lead to output losses that are twice as large (IMF World Economic Outlook, 2003). A 2012 laboratory experimental study[2] also shows that, compared to financial markets,real estate markets involve more extended boom and bust periods. Prices decline slower because the real estate market is less liquid.
The2008 financial crisis was caused by the bursting of real estate bubbles that had begun in various countries during the 2000s.[3]
US house price trend (1998–2008) as measured by theCase–Shiller indexRatio of Melbourne median house prices to Australian annual wages, 1965 to 2010
As with othereconomic bubbles, there is ongoing debate about the feasibility of identifying, predicting, and preventing real estate bubbles.Speculative bubbles are characterized by sustained and systematic deviations of asset prices from their fundamental values, often driven by investor behavior and market sentiment rather than underlying economic indicators.[4] Real estate bubbles are particularly challenging to detect in real-time due to the complex nature of property valuation and the influence of various local and global factors. While economists have developed models to estimate fundamental values—such as analyzing rental yields or comparing price-to-income ratios—accurately forecasting future bubbles remains a significant challenge.[1]
In real estate, fundamentals can be estimated fromrental yields (where real estate is then considered in a similar vein to stocks and otherfinancial assets) or based on a regression of actual prices on a set of demand and/or supply variables.[5][6]
American economistRobert Shiller of the Case–Shiller Home Price Index of home prices in 20 metro cities across the United States indicated on May 31, 2011 that a "Home Price Double Dip [is] Confirmed"[7] and British magazineThe Economist, argue thathousing market indicators can be used to identify real estate bubbles. Some[who?] argue further that governments and central banks can and should take action to prevent bubbles from forming, or to deflate existing bubbles.[8]Monetary reform could prevent central banks from setting interest rates too low.[9]
Aland value tax (LVT) can be introduced to prevent speculation on land. Real estate bubbles direct savings towardsrent seeking activities rather than other investments. A land value tax removes financial incentives to hold unused land solely for price appreciation, making more land available for productive uses.[10] At sufficiently high levels, land value tax would cause real estate prices to fall by removing land rents that would otherwise become 'capitalized' into the price of real estate. It also encourageslandowners to sell or relinquish titles to locations they are not using, thus preventing speculators from hoarding unused land.
The pre-dominating economic perspective is that increases in housing prices result in little or nowealth effect, namely it does not affect the consumption behavior of households not looking to sell. The house price becoming compensation for the higher implicit rent costs for owning. Increasing house prices can have a negative effect on consumption through increased rent inflation and a higher propensity to save given expected rent increase.[11]
In some schools of heterodox economics, notablyAustrian economics andPost-Keynesian economics, real estate bubbles are seen as an example ofcredit bubbles (pejoratively[12]speculative bubbles), because property owners generally use borrowed money to purchase property, in the form ofmortgages. These are then argued to cause financial and hence economic crises. This is first argued empirically – numerous real estate bubbles have been followed by economic slumps, and it is argued that there is a cause-effect relationship between these.
The Post-Keynesian theory ofdebt deflation takes a demand-side view, arguing that property owners not only feel richer but borrow to (i) consume against the increased value of their property – by taking out ahome equity line of credit, for instance; or (ii) speculate by buying property with borrowed money in the expectation that it will rise in value. When the bubble bursts, the value of the property decreases but not the level of debt. The burden of repaying or defaulting on the loan depressesaggregate demand, it is argued, and constitutes the proximate cause of the subsequent economic slump.
UK house prices between 1975 and 2006, adjusted for inflationRobert Shiller's plot of U.S. home prices, population, building costs, and bond yields, fromIrrational Exuberance, 2d ed. Shiller shows that inflation adjusted U.S. home prices increased 0.4% per year from 1890–2004, and 0.7% per year from 1940–2004, whereas U.S. census data from 1940–2004 shows that the self-assessed value increased 2% per year.
In attempting to identify bubbles before they burst, economists have developed a number offinancial ratios andeconomic indicators that can be used to evaluate whether homes in a given area are fairly valued. By comparing current levels to previous levels that have proven unsustainable in the past (i.e. led to or at least accompanied crashes), one can make an educated guess as to whether a given real estate market is experiencing a bubble. Indicators describe two interwoven aspects of housing bubble: a valuation component and a debt (or leverage) component. The valuation component measures how expensive houses are relative to what most people can afford, and the debt component measures how indebted households become in buying them for home or profit (and also how much exposure the banks accumulate by lending for them). A basic summary of the progress of housing indicators for U.S. cities is provided byBusiness Week.[13] See also:real estate economics andreal estate trends.
Theprice to income ratio is the basic affordability measure for housing in a given area. It is generally the ratio ofmedian house prices to median familialdisposable incomes, expressed as a percentage or as years of income. It is sometimes compiled separately forfirst-time buyers and termedattainability.[citation needed] This ratio, applied to individuals, is a basic component of mortgage lending decisions.[citation needed] According to a back-of-the-envelope calculation byGoldman Sachs, a comparison of median home prices to median household income suggests that U.S. housing in 2005 was overvalued by 10%. "However, this estimate is based on an average mortgage rate of about 6%, and we expect rates to rise", the firm's economics team wrote in a recent[when?] report.[14] According to Goldman's figures, a one-percentage-point rise in mortgage rates would reduce the fair value of home prices by 8%.[citation needed]
Thedeposit to income ratio is the minimum requireddownpayment for a typical mortgage[specify], expressed in months or years of income. It is especially important for first-time buyers without existinghome equity; if the down payment becomes too high then those buyers may find themselves "priced out" of the market. For example, as of 2004[update] this ratio was equal to one year of income in the UK.[15] Another variant is what the United States'sNational Association of Realtors calls the "housing affordability index" in its publications.[16] (The soundness of the NAR's methodology was questioned by some analysts as it does not account for inflation.[17]).
Theaffordability index measures the ratio of the actual monthly cost of the mortgage to take-home income. It is used more in the United Kingdom where nearly all mortgages are variable and pegged to bank lending rates. It offers a much more realistic measure of the ability of households to afford housing than the crude price to income ratio. However it is more difficult to calculate, and hence the price-to-income ratio is still more commonly used by pundits.[who?] In recent years,[when?] lending practices have relaxed, allowing greater multiples of income to be borrowed.
Themedian multiple measures the ratio of the median house price to the median annual household income. This measure has historically hovered around a value of 3.0 or less, but in recent years[when?] has risen dramatically, especially in markets with severe public policy constraints on land and development.[18]
Inflation-adjusted home prices inJapan (1980–2005) compared to home price appreciation in theUnited States,Britain, andAustralia (1995–2005)
Thehousing debt to income ratio ordebt-service ratio is the ratio of mortgage payments to disposable income. When the ratio gets too high, households become increasingly dependent on rising property values to service their debt. A variant of this indicator measures total home ownership costs, including mortgage payments, utilities and property taxes, as a percentage of a typical household's monthly pre-tax income; for example seeRBC Economics' reports for the Canadian markets.[19]
Thehousing debt to equity ratio (not to be confused with the corporatedebt to equity ratio), also calledloan to value, is the ratio of the mortgage debt to the value of the underlying property; it measuresfinancial leverage. This ratio increases when the homeowner takes asecond mortgage orhome equity loan using the accumulated equity as collateral. A ratio greater than 1 implies that owner'sequity is negative.
Bubbles can be determined when an increase in housing prices is higher than the rise in rents. In the US, rent between 1984 and 2013 has risen steadily at about 3% per year, whereas between 1997 and 2002 housing prices rose 6% per year. Between 2011 and the third quarter of 2013, housing prices rose 5.83% and rent increased 2%.[20]
Theownership ratio is the proportion of households who own their homes as opposed torenting. It tends to rise steadily with incomes. Also, governments often enact measures such astax cuts or subsidized financing to encourage and facilitatehome ownership.[21] If a rise in ownership is not supported by a rise in incomes, it can mean either that buyers are taking advantage of lowinterest rates (which must eventually rise again as the economy heats up) or that home loans are awarded more liberally, to borrowers with poor credit. Therefore, a high ownership ratio combined with an increased rate ofsubprime lending may signal higher debt levels associated with bubbles.
Theprice-to-earnings ratio orP/E ratio is the common metric used to assess the relative valuation ofequities. To compute the P/E ratio for the case of a rented house, divide theprice of the house by its potentialearnings ornet income, which is the market annualrent of the house minus expenses, which include maintenance and property taxes. This formula is:
The houseprice-to-earnings ratio provides a direct comparison with P/E ratios utilised to analyze other uses of the money tied up in a home. Compare this ratio to the simpler but less accurateprice-rent ratio below.
Theprice-rent ratio is the average cost of ownership divided by the received rent income (if buying to let) or the estimated rent (if buying to reside):
The latter is often measured using the "owner's equivalent rent" numbers published by theBureau of Labor Statistics. It can be viewed as the real estate equivalent of stocks'price-earnings ratio; in other terms it measures how much the buyer is paying for each dollar of received rent income (or dollar saved from rent spending). Rents, just like corporate and personal incomes, are generally tied very closely tosupply and demand fundamentals; one rarely sees an unsustainable "rent bubble" (or "income bubble" for that matter).[citation needed] Therefore a rapid increase of home prices combined with a flat renting market can signal the onset of a bubble. The U.S. price-rent ratio was 18% higher than its long-run average as of October 2004.[22]
Thegross rental yield, a measure used in the United Kingdom, is the total yearly gross rent divided by the house price and expressed as a percentage:
This is the reciprocal of the house price-rent ratio. Thenet rental yield deducts the landlord's expenses (and sometimes estimated rental voids) from the gross rent before doing the above calculation; this is the reciprocal of the house P/E ratio.
Because rents are received throughout the year rather than at its end, both the gross and net rental yields calculated by the above are somewhat less than the true rental yields obtained when taking into account the monthly nature of rental payments.
Theoccupancy rate (opposite:vacancy rate) is the number of occupied housing units divided by the total number of units in a given region (in commercial real estate, usually expressed in terms of area (i.e. insquare metres,acres, et cetera) for different grades of buildings). A low occupancy rate means that the market is in a state ofoversupply brought about by speculative construction and purchase. In this context, supply-and-demand numbers can be misleading: sales demand exceeds supply, but rent demand does not.[citation needed]
Measures of houseprice are also used in identifying housing bubbles; these are known ashouse price indices (HPIs).
A noted series of HPIs for the United States are theCase–Shiller indices, devised by American economistsKarl Case,Robert J. Shiller, andAllan Weiss. As measured by the Case–Shiller index, the US experienced a housing bubble peaking in the second quarter of 2006 (2006 Q2).
As of 2007[update], real estate bubbles had existed in the recent past or were widely believed to still exist in many parts of the world.[25] includingArgentina,[26]New Zealand,Ireland,Spain,Lebanon,Poland,[27] andCroatia.[28] Then U.S. Federal Reserve ChairmanAlan Greenspan said in mid-2005 that "at a minimum, there's a little 'froth' (in the U.S. housing market) … it's hard not to see that there are a lot of local bubbles."[29] TheEconomist magazine, writing at the same time, went further, saying "the worldwide rise in house prices is the biggest bubble in history".[30]
In France, the economist Jacques Friggit publishes each year a study called "Evolution of the price, value and number of property sales in France since the 19th century",[31] showing a high price increase since 2001. Yet, the existence of a real estate bubble in France is discussed by economists.[32] Real estate bubbles are invariably followed by severe price decreases (also known as ahouse price crash) that can result in many owners holding mortgages that exceed the value of their homes.[33] 11.1 million residential properties, or 23.1% of all U.S. homes, were innegative equity at December 31, 2010.[34] Commercial property values remained around 35% below their mid-2007 peak in theUnited Kingdom. As a result, banks have become less willing to hold large amounts of property-backed debt, likely a key issue affecting the worldwide recovery in the short term.
By 2006, most areas of the world were thought to be in a bubble state, although this hypothesis, based upon the observation of similar patterns in real estate markets of a wide variety of countries,[35] was subject to controversy. Such patterns include those of overvaluation and, by extension, excessive borrowing based on those overvaluations.[36][37]TheU.S. subprime mortgage crisis of 2007–2010, alongside its impacts and effects on economies in various nations, has implied that these trends might have some[which?] common characteristics.[25]
This section needs to beupdated. Please help update this article to reflect recent events or newly available information.(March 2020)
The Washington Post writer Lisa Sturtevant thinks that her audience will buy articles telling them that the housing market of 2013 was not indicative of a housing bubble. "A critical difference between the current market and the overheated market of the middle of last decade is the nature of the mortgage market. Stricter underwriting standards have limited the pool of potential homebuyers to those who are most qualified and most likely to be able to pay loans back. The demand this time is based more closely on market fundamentals. And the price growth we’ve experienced recently is 'real.' Or 'more real.'"[39] Other recent research indicates that mid-level managers in securitized finance did not exhibit awareness of problems in overall housing markets.[40]
EconomistDavid Stockman believes that a second housing bubble was started in 2012 and still inflating as of February 2013.[41] Housing inventory began to dwindle starting in early 2012 ashedge fund investors and private equity firms purchase single-family homes in hopes of renting them out while waiting for a housing rebound.[42][43] Due to the policies of QE3, mortgage interest rates have been hovering at an all-time low, causing real estate values to rise. Home prices have risen unnaturally as much as 25% within one year in metropolitan areas like the San Francisco Bay Area and Las Vegas.[44]
After theCOVID-19 pandemic, the U.S. housing market saw a significant rise in home prices,[45] driven by a severe supply-demand imbalance. The pandemic disrupted supply chains and slowed housing construction, leading to a shortage of available homes. This shortage, coupled with increased borrowing costs due to the Federal Reserve's interest rate hikes, contributed to the soaring prices. Experts note that the current price increases are based on market fundamentals rather than speculative behavior, highlighting the ongoing issue of housing affordability.[46]
^Ikromov, Nuridding and Abdullah Yavas, 2012a, "Asset Characteristics and Boom and Bust Periods: An Experimental Study".Real Estate Economics. 40, 508–535.
^"Headlines in the financial press ranged from “Property slowdown fuels China fears” to “China property correction would be painful, but salutary” (Financial Times, 2014e, p. 3). Housing demand has been increasing due to higher incomes, rapid urbanization and China’s rural urban migration strategy"
Burton G. Malkiel (2003).The Random Walk Guide to Investing: Ten Rules for Financial Success, New York: W. W. Norton and Company, Inc.ISBN0-393-05854-9.
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