Hi,
How to know if a region is having a real estate bubble? What metrics? Rules of thumbs?
Often the price of real estate gives a clue.
How will price alone tell you anything useful?
I think the only definitive way to know is retroactively, after a bubble bursts. That doesn’t help much, unfortunately.
Otherwise, look at the historic trending of price. If home values increase dramatically, that’s an indicator of a possible bubble. If the nature and cause of increased home values is due to a fad of sorts, if many say “X is the hot place to buy right now,” that’s another indicator of a possible bubble.
Key word above: possible.
One sure sign is the number of people who start claiming that, after a long period of increase, the price can only keep going up.
Cynical: People start talking about what a good investment real estate is.
There is a measure for real estate, similar to the Price/Earnings ratio for stocks, which is the ratio of the price of a home to the cost of renting an equivalent home for a year. If the price of homes go up, but that ratio stays more or less the same, it’s probably just inflation. If that ratio goes up, it’s probably a bubble.
A good indicator of a bubble is if prices to buy a house escalate while rents do not. This can be predictive. There were a number of people who categorized what was happening in the US a few years ago as a bubble, and they made their case by showing charts of rents versus sale prices. The arguments I remember (but didn’t find in a quick Google search) said the because rents were stable in a given market while sale prices had gone up 50%, it was a bubble.
Ah, ninja’d by leahcim.
There are metrics that compare the median housing price to either median salary or rent for comparable housing. The bottom graph here has the historic price to rent ratio, and it exploded similar to the housing prices.
The rules of thumb that I have seen are:
–median house price should be about 2.5 times median income
–price to rent ratio should be around 12 to 15 (ratio = house price / (12 * monthly rent))
In 2005 or so, the median housing price was about 4 times the median income in the US. The price to rent ratio was around 20.
I am skeptical about the ability of economic experts to predict real estate bubbles. I live in Toronto, and for as long as I have been interested in real estate - a bit over a decade now - I’ve been hearing that we are in a bubble.
I bought my house over seven years ago, against the advice of many experts - who said, wait for the bubble to bust and then buy. I’m very happy I did not take this advice. The estimated price of my house has nearly doubled in that time. Not that I care about its value (except that it increases my taxes!) as I don’t mean to sell - it is just I could not afford to buy my house if I had to do it now.
Now, pretty well every article states that we are in a bubble and prices are about to crash. They could be right - certainly the statistics they quote look convincing. Only, they said the same thing last year, the year before that, and the year before that … back a decade. When house prices crashed in the US, they said we were going to crash too. It never happened.
No doubt the bubble will burst eventually - prices cannot, after all, go up forever. However, as a buyer (to live in and not primarily as an investment), I think it is a fool’s game to attempt to time the market. Better to buy (or rent) depending on your preference and within the range you can reasonably afford at the time.
I think the difference between a hot market and a bubble is that bubbles are driven by speculation. That is to say properties are being bought as investments because the prices are rising, rather than being bought to live in in_spite_of the fact that prices are rising.
How to quantify that notion is of course a problem. You might be able to look at turn over rates. If some percentage of homes are being resold after, say, less than two years, it may indicate that the buyers are investing rather than looking for a place to live. VA and FHA loans are generally not available to investors, so if few buyers are using those means, you are probably looking at a bubble.
The time issue is probably key. Moving is a hassle, and few families are going to buy a house they expect to live in less than five years. Investors, on the other hand, prefer to make a quick buck, and profit before the bubble bursts, and the financing (“leverage”) they used is going to eat a lot of profit if they can’t flip the house fairly quickly.
Agree with this. Looking at the level of house flipping is a good indicator.
However, it is fairly easy to tell if you are in a bubble - what is tough is predicting when the bubble is going to burst, and how badly prices will drop. There were lots of people who delayed purchasing because of the bubble only to see prices increase even more - when they finally did buy and got hurt even worse than if they had bought immediately.
If you are not buying for speculative purposes, fluctuations in the market price after you bought should not matter all that much - except to the extent that you are missing out on an opportunity to buy a bigger place for the same cash (if the price goes down) or your property taxes increase (if the price goes up).
Unless you have to move …
If everyone is talking about it; if people invest as a way to make a quick buck (as opposed to buying a house to live in); if every program on teh house-and-garden channel seems to be about buying and flipping real estate, or fixing and selling; if prices go up significantly more than inflation* - then you are in a bubble.
Basically - a bubble is the altest and greatest place to park your mioney because nothing else is giving that rate of return; it may be mining stocks, internet stocks, east Asia stocks, real estate, gold, whatever…
*The rule of thumb is “if things can’t keep going this way… they won’t.”
A few thing to watch for in some markets. Houses selling for above the asking price. People buying perfectly good houses then demolishing them to build an even bigger one. I know there could be other factors but it is something to take a look at. It can be indicative of other bubbles but if they burst so can the housing market. Look for stuff that does not make sense.
Could Norway be in a housing bubble?
Or refinance. But if the price is very high relative to your income, there is incentive to wait if you think the price will come down. And if keeps going up, some people start to panic. I thought the prices were absurdly when I bought, which was well before the bubble started and when I was coming from a reasonably expensive market.
In California, our property taxes don’t increase much after we buy even if the price does go up.
During the bubble there was also the home equity issue, in that the radio was flooded with ads calling you an idiot if you didn’t cash in on your equity. Maybe that is a good metric, since it only makes sense if people have “free” equity.
I’m starting to hear them again…
I use “housing bubble” as an explanation of last resort for rising prices. So, if I can find any suitable reason for increasing prices - increase in population, increase in salary, inflation, etc. - then I tend to assume those are the reasons and it is not a bubble. Then I can look at how stable the controlling factors are to estimate the future.
But, seriously, why would we assume that a layman can spot a housing bubble? If a million-dollar, full-time expert at a bank can’t call it, what special wisdom do you think you’ll bring to the table? By their very nature, bubbles are remembered and not predicted.
So my real philosophy about these things is:
- If you need a house and can afford to buy it at current prices, go buy it. Bubbles can last for quite a while and even the experts can’t predict them.
- If you’re buying because it’s an investment, make sure that you’re properly diversified. Never put all your eggs in one basket, no matter how good it looks.
I’ve lived through a housing bubble. It was as obvious as a hammer between the eyes, and I don’t mean in retrospect either. When houses appreciate $100,000 every time they change hands? When our funky 2 bedroom 1 bath is appraised at $800,000? What do you call that? What was keeping “laymen” from spotting it was just greed and wishful thinking – same thing as kept all the full-time experts from spotting it. It wasn’t unpredicted by dispassionate observers – it’s just that no one listened to them.
A big tipoff is when the seller starts playing games with the monthly payment amount:
Sure, it says a million, but you’re only paying the same as you would for a half-million!*"
*- for the first year. Then it goes up to what a million really costs, but what’s to worry? You can just re-fi to get another feels-like-a-half loan or sell for a profit! You Can’t lose!
Those last 3 words are: Run, Run Hard. Run Fast. Run Long.
You don’t even need to buy to play this game: There was a huge apartment complex which had just changed hands. The contract said $1500/mo. Way too much for that unit.
But! "don’t worry - that number is just there to make the investors happy - here’s 12 coupons - one for each month - just send along a coupon and $900, and we’re cool.
Of course, you’ll get another coupon book next year.
Except that part about “next year” wasn’t what the contract said.
Take a guess what happened to those who sent in $900 for that 13th payment?
Some hints we had in Spain:
- houses being built in what had previously been prime real estate for other uses (such as fertile land at the riverside which had been vegetable gardens for centuries),
- and which was actually pretty bad land for housing (continuing the example above, one of the reasons the land was used for veggies is that it was wet and spongy),
- people who would normally have no reason to look into real estate as a business proposition (such as cabbies or people in their first jobs) buying houses not to live in them but “as an investment”, to flip,
- too many houses for the amount of people. The town where I grew up now has enough housing that every single person over the age of 18 could have one - that simply makes no sense.