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How to Tell that a Real Estate Market is Overheated

By May 30, 2015 No Comments

The Problem of Economic Bubbles

Excessive enthusiasm is a problem that has been afflicting the markets since the beginning of human civilization, so it should come as no surprise to learn that it has been responsible for causing a remarkable range of economic bubbles over the centuries. For example, the Dutch Golden Age saw the rise and fall of tulip mania, which managed to convince some of the shrewdest businessmen of early modern Europe to pay up to thousands of gold coins for single tulip bulbs.

With that said, even the most ridiculous of economic bubbles become much less entertaining when they begin encroaching on our economic well-being, as is the case of economic bubbles in the real estate market. Not only can their existence fill the real estate market with dangerous levels of risk, but the sheer importance of the real estate market means that they can have a significant impact on the rest of the economy as well. As a result, keeping an eye out for economic bubbles is a must for Realtors and other real estate professionals that are reliant on the real estate market for their living.

What Are the Signs of a Real Estate Bubble?

Here are the most common signs of an economic bubble in the real estate market:

1. Sharp, sudden increases in real estate prices tend to be a troubling sign. However, it is important to note that there is no single factor that can be used to tell if such increases signal a sustained trend or a genuine economic bubble. Instead, such increases have to be interpreted in the context of other measurements about the real estate market for the surest results. For example, if the increase in real estate prices has begun making it impossible for housing consumers to buy their homes, then the situation becomes more and more like an economic bubble. After all, no matter how enthusiastic housing consumers might be, their income sets a hard limit on how much they can spent on housing. Generally speaking, housing consumers spending more than 30 percent of their income on housing costs is a sign that real estate prices are too high, though this is by no means a universally applicable rule.

2. Rising real estate prices lead to an increase in the number of real estate properties being sold, both because of builders and because of homeowners putting their homes up for sale. This can coincide with an eventual fall in real estate prices to send them plummeting further, which is part of the reason that the bursting of an economic bubble is bad. If the supply of real estate properties begins outpacing the demand, it could be a sign that a hard correction is coming.

3. Low borrowing rates can encourage the excessive enthusiasm responsible for creating economic bubbles. When a rise in interest rates cause borrowing rates to soar, that makes housing loans more burdensome, which can lead to an increase in loan delinquency rates. Something that can create a self-perpetuating loop.

Conclusion

Of course, these are but some of the potential signs of an economic bubble in the real estate market. For the best results, Realtors and other real estate professionals need to pay close attention to the real estate market while doing their best to avoid being swept up in the contagious enthusiasm that can be all too common at times.