When investing, most people understand and accept that there is a risk that prices may fall, but this expectation is not managed when investing in a property. In this article, we will discuss the housing bubble and how investors should manage this. Most times it is difficult to ascertain when a target property is in a market bubble or not. The best way to understand this is to take into consideration the risks involved and factor this when making an informed investment decision.
What is a housing bubble?
A housing bubble is a run-up in housing prices. This is due to a sudden growth in property prices, as speculators pour money into the market, until a point that demand decreases while properties continue to be introduced into the market, resulting in a sharp drop in prices.
Although a housing bubble is only a temporary event and is usually driven by something outside the norm such as high levels of investment. However, it can take time to normalise.
Traditionally, housing markets are not as prone to bubbles due to the large transaction and carrying costs associated with owning a property. However, with very low-interest rates and a loosening of credit underwriting standards can lead to increased demand in the market.
Why Housing Bubbles Burst?
Like every other product available in a free market, prices for properties are driven by supply and demand. Demand means the number of investors/people who have and are willing to act on the intent to purchase/invest in property, therefore, driving prices up. These prices are pushed up because it outpaces the available number of properties available in the market. This demand is generally caused by these several reasons (Why Housing Market Bubbles Pop - Nielsen, B 2019):
An upturn in general economic activity and prosperity that puts more disposable income in consumers' pockets and encourages homeownership.
An increase in the population or the demographic segment of the population entering the housing market.
A low, general level of interest rates, particularly short-term interest rates, that makes homes more affordable.
Innovative mortgage products with low initial monthly payments that make homes more affordable.
Easy access to credit—a lowering of underwriting standards—that brings more buyers to the market.
High-yielding structured mortgage bonds, as demanded by investors, that make more mortgage credit available to borrowers.
Potential mispricing of risk by mortgage lenders and mortgage bond investors that expand the availability of credit to borrowers.
The short-term relationship between a mortgage broker and a borrower under which borrowers are sometimes encouraged to take excessive risks.
A lack of financial literacy and excessive risk-taking by mortgage borrowers.
Speculative and risky behaviour by home buyers and property investors fueled by unrealistic and unsustainable home price appreciation estimates.
The forces that burst the Bubble are:
An increase in interest rates that puts homeownership out of reach for some buyers and, in some instances, makes the home a person currently owns unaffordable. This often leads to default which eventually adds to the current supply available in the market.
A downturn in general economic activity that leads to less disposable income, job loss and/or fewer available jobs, which decreases the demand for housing.
Demand is exhausted, bringing supply and demand into equilibrium and slowing the rapid pace of home price appreciation that some homeowners, particularly speculators, count on to make their purchases affordable or profitable. When rapid price appreciation stagnates, those who count on it to afford their homes may lose their homes, bringing more supply to the market.
Is the Australian Property Market in a Bubble?
According to Wikipedia, Australian house prices rose strongly relative to incomes and rents during the late 1990s and early 2000s; however, from 2003 to 2012 the price to income ratio and price to rent ratio have both remained fairly steady, with house prices tracking income and rent growth during that decade. Since 2012 prices have once again risen strongly relative to incomes and rents. In June 2014, the International Monetary Fund (IMF) reported that house prices in several developed countries are "well above the historical averages" and that Australia had the third-highest house price-to-income ratio in the world. In June 2016, the Organisation for Economic Co-operation and Development (OECD) reported that Australia's housing boom could end in 'dramatic and destabilising' real estate hard landing. As of December 2018, Sydney and Melbourne along with some regional cities have experienced price declines of up to 10% over the year, with a further 10-20% forecast in the near future. Declines were largely triggered by the significant tightening of lending standards following the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry that revealed mortgage fraud aka subprime 'liar loans' and widespread irresponsible lending practices. However, there is mounting evidence that the housing bubble is entering the correction phase. Further evidence of a correction, is that there is increasing pressure to raise interest rates on mortgage products from April 2018 onwards.
Is it wise to invest in properties during a recession?
As reported by Lake and Likos, 2020 "Real estate is an interesting asset," says Mihal Gartenberg, an agent at New York-based Warburg Realty Partnership. "When the stock market is doing poorly, investors who are looking for other opportunities find that real estate is a safe haven."
Gartenberg adds, "The fact that the last recession was caused by the real estate bubble has remained strong in investors' minds, making them think that recessions lead to depressed real estate prices," she says. "Even though during three of the last five recessions, real estate values actually increased."
Property investments can produce stable income. As an income stream, real estate investing tends to offer predictability in a recession. "Consistency of the yield is what makes real estate investments more suited for riding out a recession," says Jason Laux, owner and retirement advisor at Synergy Group in White Oak, Pennsylvania.
Property is less sensitive to volatility. "Because of the steady nature of revenues from real estate, it can often be a good hedge against volatility," says Diana Hill, director of real estate education at OTA Real Estate. "Even in times of recession, people need places to live, work and get services. So the market will always exist."
The quality of the property investment can directly dictate how well real estate performs in comparison to other securities.
Properties have historically proven to be a safe haven for investors during recessions and provide a stable cash-flow source. If you have any questions you can Contact Us or drop us a DM on Facebook.