With housing inventory still lagging, sellers continue to have the upper hand.
What is a real estate bubble?
A real estate bubble, also referred to as a “housing bubble,” occurs when the price of housing rises at a rapid pace, driven by an increase in demand, limited supply and emotional buying. Once speculators recognize that housing prices are on the rise, they enter the market, further driving up demand. The phenomenon is called a bubble because at some point it will burst.
In early 2006, the price of housing in the U.S. peaked. By the end of that year, prices began to soften, and by 2007 the bubble burst. Those who had overpaid for their homes panicked as they realized the degree to which they were “underwater.” In other words, millions of homeowners suddenly owed far more on their property than they could expect to sell it for.
In a normal market, a homeowner buys a property and expects it to increase in value slowly. Most homebuyers realize that it can take decades to build equity, and they are fine with that fact. In the meantime, they have a roof over their heads and a tax deduction. Few homebuyers expect to get rich from their investment.
In contrast, speculators jump into the housing market as soon as prices begin to rise at a faster-than-normal rate. Their primary aim is to buy while the market is getting hot and quickly sell to someone else who is willing to pay an even higher price.
According to the American Monetary Association, real estate bubbles are driven by speculation, and speculation is grounded in human psychology. Investors swoop in and buy up property, which leads ordinary Americans with fewer financial resources to see an opportunity to make a quick profit. Throwing sense out the window, they begin to pay too much for an asset.
Real estate bubble example
The financial crisis of 2007–08 was related to the bursting of a real estate bubble which had begun during the 2000s. On Dec. 30, 2008, the Case-Shiller home price index reported its largest price drop in its history. Housing prices had peaked in early 2006, started to decline in 2006 and 2007, and reached new lows in 2012.
Even so, housing starts and prices have increased in many areas in recent years, while rates remain low. But the question of whether the U.S. is heading toward a new housing bubble in some areas remains debatable. The previous bubble was driven in part by leveraged debt, or subprime or no-doc loans, and house flipping. Those factors aren’t as prevalent today, and that may mean the nation’s real estate market has yet to reach bubble status.