Looking at real estate-centric headlines, you can almost immediately sense the anxiety. We’re not sure those feelings are well-founded. After all, it’s almost always the same song and dance: Is the real estate market going to crash? Why does this remind us of 2008? Things are bad!
Now, we won’t sit here and say that things are peachy and will always be that way. We know that the real estate market fluctuates, sometimes in unpredictable ways. However, we also don’t see much merit in invoking the Great Recession or approaching the market from a sense of fear and anxiety.
Instead of worrying about a market crash in some vague way, we must understand why real estate crashes happen to begin with. We’ll be better equipped to see and assess concrete signs when we do. It helps real estate investors act based on data – not fear!
A real estate market crash is typically caused by a combination of factors that affect the overall economy, the housing market specifically, and the behavior of buyers, sellers, and financial institutions. Understand that there’s rarely one thing that causes the bubble to burst.
Here are a few of the major players:
Supply and demand dynamics are at the heart of housing market health. The economy plays the most prominent role in these dynamics. If jobs were being cut and we were battling a massive unemployment crisis, perhaps there would be more reason to worry. But currently, we’re experiencing a housing shortage paired with stable job creation.
Yes, affordability is an issue. Yes, people are still feeling inflation despite its improvements. However, short of a true, demonstrable blow to consumer confidence and stability, we’re on relatively solid ground right now.
When home prices rise too quickly, they can become disconnected from the underlying fundamentals like income levels, rent prices, and local economic conditions. This overvaluation can create a bubble where home prices are artificially high. Demand shrinks once prices reach unsustainable levels, and the bubble bursts, causing prices to fall sharply.
Further Reading: Worried About the Real Estate Market? Here’s the Secret to Investing.
Subprime lending was at the heart of the 2008 Great Recession. These are loans offered to high-risk borrowers, particularly those with poor credit or irregular income. When large numbers of these borrowers cannot repay their loans, it can lead to widespread defaults and foreclosures. Again, this dumps supply onto the market while pulling back on demand.
Financial institutions may tighten credit when they become more cautious due to rising risk or economic uncertainty. This means it becomes harder for individuals to get mortgages, even if qualified, due to stricter lending standards.
A decrease in mortgage availability can lower the number of potential homebuyers, leading to a surplus of unsold homes. If this persists, it can cause a downward spiral in prices.
That’s not the only potential roadblock for would-be homebuyers, though. High levels of household debt – debt from student loans, medical expenses, credit cards, and other sources – can decrease the willingness (and ability) to take on a mortgage.
Sometimes, the market crashes or dramatically shifts because something comes out of left field. Natural disasters, geopolitical upheavals, war, global pandemics…these extreme conditions can all radically impact a housing market on both a local and national scale.
Imagine an island that shows up out of nowhere. Everyone hears how incredible this place is. Beautiful, full of natural resources, and so much potential and opportunity! There’s a mad scramble to be the first to get there. People flock to the island, which quickly becomes too crowded and expensive. To make matters worse, most people there focus on profiting off the island instead of investing in it.
So when those people abandon the island, they leave behind a glut of houses. The frenzy is over; there isn’t enough demand to prop up the sky-high prices. And so they crash.
Speculation, where people buy properties not to live in but to sell them for profit, leads to rapid price increases (a bubble) that can collapse when speculative demand evaporates.
When central banks (like the Federal Reserve here in the U.S.) raise interest rates to combat inflation or cool down an overheated economy, borrowing becomes more expensive. Higher mortgage rates can reduce demand for housing, making it harder for buyers to afford homes and leading to a drop in home prices. This curbs the demand on the market while also making it more challenging to refinance.
Still, interest rates can have an unpredictable impact. In the last few years, interest rates increased to rein in the housing market’s big gains. Because supply is short and demand is so high, it didn’t temper the market in the way they hoped.
Ultimately, we’re not seeing the big warning signs of a real estate market crash. Investors would do well to stay the course with diligence and attention to detail. Focus on the long-term and on making your investments the best they can be.
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