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What is a real estate bubble?

Published on January 13, 2020

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When the real estate market becomes exceptionally strong very quickly, observers may become concerned that a real estate bubble phenomenon is occurring. But what exactly does that mean? 

A real estate bubble results from a very swift rise in property prices, without a corresponding growth in the economy or in people’s standard of living. This creates a risk of the market being overvalued. 

In this type of situation, factors like speculation, a sudden hike in demand, or other elements such as investors not understanding the market, are responsible for the unreasonable increase in prices. 

How does it happen?

A real estate bubble appears when the market overreacts and the demand severely outpaces the supply. There are a host of reasons that can lead to such a situation. 

One example is real or expected interest rate fluctuations. When the rates are low, the demand from buyers surges. If the borrowing context is easy, some people looking to buy will be willing to take on more debt and buy at a higher price. 

The impression that there is a shortage of supply can also cause buyers to attach more value—sometimes excessive value—to certain property types. This belief also plays a role in increasing prices and possibly in unsettling the market. 

What are the consequences?

If property prices continue to rise while demand remains the same, the market may balance out without too many negative effects.

The most serious risk of popping a real estate bubble is causing a crash. An abrupt drop in demand would then cause property values to tumble. 

In this case, homeowners would find themselves paying back a mortgage loan for more than their home is even worth.

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