We know you read the news. We know you lived through 2008. We know you are seeing home prices and wondering if history is going to repeat itself. While we don’t read crystal balls, we do believe that all information is power. This week we wanted to briefly review when bubble fears are founded, and what distinguishes a crash vs. correction. Home prices will change at some point – and it’s better to know what thresholds are cause for concern and which standard market conditions to expect.

The housing bubble concerns emerge when home prices rise rapidly, but become more serious when housing prices rise faster than the rate of inflation. According to analysts Bing Bai & Edward Golding from the Urban Institute (UI), rapidly growing prices are ‘benign’ when caused by market fundamentals such as job and income growth. A bubble refers to home prices inflated by artificial or temporary factors creating an immediate rise amidst unsustainable conditions.

For comparison, the difference between price growth and inflation was 87% between 1997 and 2007, yet 34% between 2012-2017. In addition, the UI analysts believe that a median household can afford a home that costs $70,000 more than the actual median prices of homes being sold (based on the Housing Finance Policy Center's Housing Affordability Index). Yet they also report that national averages are different than local markets who exhibit ‘bubblicious’ tendencies. Interestingly, cities whose prices place them one watch list are those whom have been constrained most by lack of building and of most interest to international investors. Public policy decisions with regards to rate increases and land use decisions should consider data in local markets as well as national averages. In the meantime, data analysis is focused on better refinement of measurements that differentiates between a healthy housing market and territory that’s on the edge.

So when and if prices DO drop – is it automatically a sign of a crash? The answer lies in how much. According to Business Insider:

“A real estate correction is relatively minor drop in the market. The market is in correction territory when the home price index falls not more than 10% from the highest price within a year.”

“A real estate crash is much less common than the media would have you think. When the home price index falls by more than 10% from the 52-week peak value, you’re experiencing a crash.”

In addition, crashes usually occur in conjunction with other strong economic conditions such as GDP changes, unemployment spikes, etc. Are we likely to see both corrections and crashes in our lifetime. Yes. But that should not stop you from buying real estate – it should just serve as a reality check that when you invest, what you buy & where plus how long you plan to own it are extremely important factors to consider beforehand.

As Warren Buffett said… “Only when the tide goes out do you discover who’s been swimming naked.”

Resources Used:

Price Gains Built on Fundamentals or Full of Hot Air?

Here’s The Difference Between A Real Estate Correction And A Crash

All our best,

Mark & Jason