Two main scenarios can lead to an increase in housing prices:
- The entire economy of an area has changed. The standard of living in that region has improved, and more jobs are available, making it necessary for people to move there.
- A speculative boom could occur where investors purchase at a high cost today to sell it at a higher price tomorrow.
How can one predict the market? What are the best ways to distinguish between a realistic price increase and a bubble? We will try to answer this question in this article.
Interest rates have always been a common factor for every boom-and-bust scenario in the real estate market. It is debatable whether or not they are directly responsible. They are certainly one of the leading causes.
Low-interest rates have led to all the booms in the real estate market, whether in Japan, the United States, or China. Low-interest rates cause excess money and buyers to rush to purchase homes.
It is also true that the opposite is true. The sudden and unexpected rise in interest rates has also caused all the problems in the real estate market. The rising interest rates are the root cause of all crises, from the subprime mortgage crisis to the “lost decade.”
An investor should avoid markets where a falling interest rate fuels property price increases. In most cases, this is likely a real estate bubble.
The housing inventory is another essential metric real estate investors use to determine if a market has bubbled. The housing inventory is the number of unsold house developers in a market.
The housing stock in a typical market is stable. Developers know how many homes buyers will buy in a certain period and build houses to meet that demand. When a bullish market is about to begin, the housing inventory suddenly becomes scarce. There will be no houses available on the market. In contrast, the housing stock increases suddenly during a bearish market. There are many homes on the market. However, there are only so many buyers willing to buy them.
Keeping an eye on housing inventory numbers can help investors determine the current stage of the economic cycle.
Housing inventory is the opposite. Housing inventory is the number of unsold houses in a particular market over a certain period. On the other hand, absorption rates tell us how many homes have been bought on the market over time. The number of requests for the transfer of title to property received by the government can be used to estimate this number. A rising number indicates a bull market, while a declining number indicates a bear market.
Earnings to Capital Values
A second way to measure affordability is by comparing the average annual wage of a person living in a particular neighborhood with the capital values of the area. This will tell us how many years a person has to work to afford a home in a specific site. Average wages are estimated by comparing the median salary of workers in a room.
Numbers between 5 and 10 indicate affordability. If a person can buy a home with 100 percent of their salary in five to ten years, they can also afford a mortgage for 20 years. If the number exceeds 20, this indicates a housing bubble.
This high price may be because investors drive the market, and the average tenant is only a renter!
Renting to Capital Values
Comparing rental and capital values is one of the best ways to forecast a housing boom—rent and capital values both change when the economic fundamentals of a property change.
In the event of a property bubble, however, investors will raise capital values in anticipation of even more significant capital gains. Rents do not increase because tenants don’t see any change in property value. In such markets, there is a substantial disparity between the rental and capital value which can be considered a sign of a real estate bubble.
There are many indicators on the property market that can help an investor distinguish between a rise in price and a bubble.