A real estate bubble is the excessive and unjustified increase in real estate prices. Generally, the cause of real estate bubbles is speculation.
In other words, a real estate bubble supposes the exorbitant growth of housing prices without reasons that truly justify the increase in the value of real estate.
From the economic point of view, a bubble implies that the excessive increase in property prices occurs well above the economic growth of a country. Hence, there comes a time when real estate bubbles burst with a sharp drop in prices, endangering the country’s economy.
What factors end up causing real estate bubbles?
The factors that end up causing these bubbles are:
- The speculation: The great reason for real estate bubbles is speculation. This implies the acquisition of real estate to later sell it at a higher price. Thus, construction companies request more loans, while the demand for real estate soars and prices increase considerably.
- Increase in mortgage loans: Every housing bubble brings with it a sharp increase in mortgage loans. However, there is no certainty as to how long the price of housing will continue to grow, while, on many occasions, banks grant loans to non-solvent clients. In the midst of this maelstrom, loans are offered in more affordable conditions, continuing with the dynamics of building new properties.
- Building land: Given the strong pull of construction, this becomes a sector of great importance in the national economy. Therefore, the public sector will not put obstacles to the approval of new urbanizable lots, quite the contrary. Thus, a large number of new urbanizations arise in deserted lots.
- Second homes: Given the flexibility of credit, with very favorable conditions for individuals, many are encouraged to purchase a second home. There are those who do it to enjoy a second home or to obtain a capital gain when selling that second property. In any case, the result is a strong increase in the demand for housing, which leads real estate developers to build new developments. All this contributes to fueling the growth of housing prices and, therefore, fuels the housing bubble.
What does the bursting of a housing bubble mean?
After years of unjustified growth in housing prices, the bursting of the housing bubble may come. There comes a time when customers, in situations of insolvency, cannot afford mortgages. Credit institutions begin to repossess homes and real estate ceases to be a reliable asset, causing a sharp drop in property prices.
The consequences of a real estate bubble bring with them devastating economic effects. Construction ceases to be a buoyant sector and numerous direct and indirect jobs are destroyed, causing a sharp increase in the unemployment rate.
Given the risk of insolvency of new customers, banks raise interest rates, while confidence in the economy crumbles.
The country will be dragged into recession and, in the face of poor economic prospects, business investment declines markedly. In fact, there are massive layoffs in the private sector, which leaves many workers without the sustenance of their salary, which reduces the consumption of domestic economies and negatively affects GDP.
How to prevent a housing bubble?
If the latest real estate bubbles have shown anything, it is that it is necessary to be more rigorous in the granting of loans, in such a way that there is no excess of credit. In this sense, adequate supervision of banking entities is of great importance.
Similarly, it is essential to monitor whether there is a gap between the increase in wages and the growth in real estate prices. In this way, it will be possible to know if the country is at risk of suffering a housing bubble.
A more ethical behavior, both at a social and business level, marked by good practices and transparency, will also make it possible to avoid an excessive growth in the price of real estate. For this, it is necessary to provide truthful information to the consumer and carry out realistic real estate appraisals.