Housing bubble: origins and impacts
Last updated on March 14, 2025
While the real estate market is often viewed as stable and solid, it can occasionally experience a dramatic downturn. A housing bubble is one such factor that can disrupt the entire market. What exactly is a housing bubble and how does one form? We’ll review this phenomenon by examining its root causes and resulting impacts.
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Overview:
- What is a housing bubble?
- What is a housing crisis?
- Three causes that explain how a housing bubble forms
- What are the repercussions?
- Buyers and sellers: how to navigate a housing bubble to ensure a successful deal?
- Analysis: Canadian real estate market
- FAQ
What is a housing bubble?
Definition and characteristics
In a booming real estate market, economists start to anxiously look for signs of a housing bubble emerging. So what is it exactly?
A housing bubble occurs when the cost of housing rises at an unsustainable rate, far outpacing economic growth and the cost of living. A risk then emerges that the market may become overvalued.
Several factors can contribute to the formation of a housing bubble, like rampant speculation, increased demand, or in some cases, an issue such as lack of market knowledge among investors could be responsible for the price surge.
History of housing bubbles
One of the most notable examples is the real estate bubble that popped up in the United States in the 2000s, just before the 2008 crisis. Banks approved mortgages for people who really couldn’t afford the repayments, causing house prices to skyrocket. When prices became unsustainable and many homeowners began defaulting on their loans, the bubble burst, triggering a global real estate and financial crisis.
What are real estate cycles?
Real estate cycles are recurring fluctuations in real estate market activity, typically influenced by the economy, interest rates and demand. These cycles are generally divided into four main phases:
- Expansion Prices rise due to strong demand and investor optimism is high. The number of new builds increase.
- Hyper supply Prices peak, supply sometimes exceeds demand, but euphoria remains.
- Recession Demand drops, prices fall, developers slow down new build projects and payment defaults go up.
- Recovery Prices stabilize at a lower level, confidence returns and investment begins to gradually resume.
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What is a housing crisis?
A housing crisis occurs when the real estate market suddenly collapses, often due to overpricing, high buyer debt or speculation. This collapse can be triggered by economic factors such as a recession, rising interest rates or oversupply in real estate. As demand decreases and prices drop sharply, many investors or owners may find themselves in debt and unable to sell at a reasonable price, leading to significant losses and exacerbating the broader economic crisis.
Three causes that explain how a housing bubble forms
1. Cyclical causes
Cyclical causes are tied to temporary events that disrupt the market, such as low interest rates that make borrowing easier and encourage property acquisition, even at inflated prices. Strong economic growth can also drive up housing demand, further pushing prices higher.
Simultaneously, access to credit with more flexible lending conditions can attract investors or buyers who may not be financially prepared. This combination creates an artificial price surge, fuelled by speculation, until the market inevitably adjusts—and the bubble bursts.
2. Regulatory causes
Regulatory causes arise from public policies or regulations that encourage excessive expansion in the real estate market. For example, relaxed lending laws or insufficient control over lending criteria can allow more people to buy property, often beyond their financial means.
Additionally, tax incentives, such as subsidies or tax reductions for the purchase of real estate, can spur speculative buying. In some cases, restrictive building standards can limit land availability, boosting demand and inflating prices.
3. Sociological causes
The sociological causes of a housing bubble stem from collective behaviours and social beliefs that drive real estate investment. When society views property ownership as a symbol of success or stability, it can lead to overzealous demand for real estate, even at inflated prices.
The desire to conform also plays a role: if everyone is in buy mode, social pressure compels individuals to follow the crowd, driven by the fear of missing out (FOMO). This trend is often amplified by media coverage of real estate successes, which promotes the perception of the real estate market as a safe investment, thus fuelling the bubble.
What are the repercussions?
If prices go up and demand remains steady, the market can stabilize without any repercussions. However, the greatest risk if a housing bubble bursting is a market crash. A sharp decline in demand would lead to a drop in property values, leaving owners potentially owing more on their mortgage than their home is worth.
Buyers and sellers: how to navigate a housing bubble to ensure a successful deal?
Whether buying or selling in a housing bubble, these no-brainer strategies are vital to successfully closing a deal.
For buyers:
- Proceed with caution Buyers should resist the urge to get caught up in a bidding war. The key consideration should be how much debt is manageable—assess your long-term repayment capacity.
- Assess a property's long-term growth potential Before proceeding, confirm that an investment sits on solid foundations. Consider factors like location, potential rental income and market stability to gauge future growth.
- Don’t follow the crowd While it may be tempting to act impulsively, take a step back and ask yourself: “Is this property worth the price?”. An emotional purchase during a bubble can lead to buyer’s remorse if the market suddenly corrects itself.
For sellers:
- Seize the day Prices rise during a housing bubble, encouraging sellers to take advantage of the market and sell high. However, it’s important to stay grounded and be realistic about a property's value, rather than be swept up in the euphoria of a market that could soon stabilize or correct itself.
- Have a Plan B Selling during a bubble can be an amazing opportunity but you need to have a post-sale strategy in place, especially if prices drop afterward. Consider reinvesting in another property when the timing is right, without rushing your decision.
- Get ready to list When prices are high, competition is often fierce among sellers. To stand out in a crowded market, it’s important to give the property a little love (minor renovations, interior staging), highlight its best features and set a competitive yet fair price.
“Timing visits to maximize your home’s appeal and setting clear benchmarks for submitting offers to purchase can be valuable strategies depending on what’s happening in the market,” says Mikaël Leclaire. “Your mission: don’t get distracted by inflated prices and establish transparent goals, such as a reasonable target price and preferred occupancy date.”
Analysis: Canadian real estate market
Current economic climate
After raising its key rate between 2022 and 2023 in an attempt to control inflation, the Bank of Canada finally cut it back in 2024. These decreases have led to lower mortgage interest rates, making the cost of borrowing more affordable for buyers. This revived demand for real estate in some parts of the country, particularly for first-time buyers and investors who have been held back by higher rates.
We may see a modest increase in prices in Montreal, Toronto and Vancouver, but it’s unlikely to reach pre-boom levels. Certain buyers who have been waiting for more favourable conditions may resume their real estate projects, leading to moderate competition in specific market segments.
The rental market is still feeling the heat, despite a decline in interest rates. Property prices are expected to remain high, driving a lot of people to rent instead. Strong demand for rental units, coupled with a limited supply, could continue to drive up rents, making it challenging for many segments of the population to own their home.
Bank of Canada’s role
The Bank of Canada plays a pivotal role in regulating the real estate market, by shaping economic conditions through its monetary policies, particularly interest rate management. Its moves have a significant impact on access to credit, real estate demand and price dynamics in the market.
1. Interest rate policy
The Bank of Canada’s most direct influence on the real estate market involves its ability to adjust the key interest rate. By modifying this rate, the Bank of Canada controls short-term interest rates (which commercial banks use to borrow money). These rates, in turn, affect mortgage rates (fixed or variable) that determine the cost of real estate loans for buyers.
- Low rates When the Bank of Canada reduces its key interest rate (as it did in 2024), mortgages become more affordable. This encourages increased demand for property, as borrowers can secure loans at a lower cost. As a result, lower rates can stimulate the real estate market, making homeownership more accessible
- High rates Conversely, by raising its key interest rate (as it did in 2022 and 2023), loans become more costly. This dampens demand by limiting borrowing capacity since higher mortgage rates lead to increased monthly payments that may be harder to manage. As a result, the real estate market may slow down, with prices stagnating or even falling due to reduced demand.
2. Influence on inflation and real estate affordability
Another key aspect of the Bank of Canada’s influence is its effort to combat inflation. In periods of high inflation, such as in 2022, the Bank of Canada typically raises its key interest rate to curb consumption and slow economic activity. This directly impacts the housing market as higher rates reduce households’ ability to qualify for loans. It can also result in lower property prices as fewer people can afford to buy.
However, when it lowers rates to stimulate the economy—in response to a recession or weak growth—this can boost affordability. This stimulation can also create a supply and demand imbalance, contributing to price increases.
3. Indirect regulation of the real estate market
Although the Bank of Canada is not directly responsible for real estate regulations, its policy instruments influence housing-related economic and government policies. Fluctuating interest rates can push the government to introduce measures aimed at curbing real estate speculation or encouraging investment in affordable housing.
The Bank of Canada also plays a key role in shaping economic forecasts, providing governments and investors with crucial economic indicators that guide decisions on real estate investment, urban planning and construction policies.
4. Indirect influence on financial stability
The Bank of Canada is also responsible for ensuring the overall stability of the financial system. The real estate market is a vital component of the Canadian economy, so must be carefully managed to prevent an unchecked housing bubble that could wreak havoc on the banking system. By adjusting interest rates, the Bank of Canada seeks to maintain balance in the real estate market, notably by minimizing the risk of excessive lending and avoiding the formation of speculative bubbles.
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FAQ
When does a housing bubble occur
It occurs due to excessive speculation, when real estate prices rise irrationally, far beyond real property values.
How to know if we’re in a housing bubble?
When prices rise quickly and continually, even if real demand isn’t apparent or household incomes don’t justify the increase.
Can a housing bubble suddenly burst?
Yes, a bubble can burst quickly if external factors shake the market, like an economic downturn, interest rate hike or natural price correction.
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