Two main scenarios can lead to an increase in housing prices:
- The fundamental 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 high prices today in order to sell them at even higher prices 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
Interest rates have always been a common factor for every boom-and-bust scenario we’ve seen in the real estate market. It is debatable whether or not they are directly responsible. They are certainly one of the main 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 an excess of money and cause buyers to rush to purchase homes.
It is also true that the opposite is also 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.”
As an investor, you should stay away from markets where the increase in property prices appears to be fueled by a falling interest rate. In most cases, this is likely a bubble.
Housing Inventory
The housing inventory is another important metric real estate investors use to determine if a market has reached a bubble. The housing inventory is the number of unsold houses that developers in a market have.
The housing stock in a typical market is stable. Developers have an idea of 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. Few buyers are willing, however, to buy them.
Keeping an eye on housing inventory numbers can help investors determine the current stage of the economic cycle.
Absorption Rates
Housing inventory is the opposite. Housing inventory is the number of unsold houses in a particular market over a certain period. Absorption rates, on the other hand, tell us how many homes have been bought on the market over some time. This number is usually calculated from the number of requests for property title transfers that the government receives. 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 would have to work to be able to afford a home to a certain extent. Average wages are estimated by comparing the median salary of workers in a room.
Numbers between 5 and 10 indicate affordability. If a person is able to buy a home with 100 percent of their salary in five to ten years, then they can also afford a mortgage for 20 years. If the number exceeds 20, this indicates a housing bubble.
This high price may be due to the fact that investors drive the market, and the average tenant is just a renter!
Renting to Capital Values
Comparing the capital and rental values is one of the best ways to identify a housing bubble. 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 greater capital gains. Rents do not increase because tenants don’t see any change in property value. In such markets, there is a large disparity between the rental and capital value, which can be considered a sure sign of a real estate bubble.
Many indicators on the property market can be used to help the diligent investor distinguish between an asset bubble and a rise in price.