Many cities have seen a significant increase in home prices in the past year, up 20% or more.
The rapid growth in the economy has made some experts question whether the boom will last or whether we will see another bubble (and then burst) like the one preceding the 2008 housing crisis.
A bubble occurs when the value of an asset (in this case, houses) rises beyond its actual value due to speculative demand.
Eventually, bubbles will pop, and investors (in this case, homeowners) lose money when prices fall back to earth, hurting the overall economy.
Whether you are a buyer or a seller, the prospect of the housing market crashing is quite unsettling. You do not want to be responsible for an overvalued asset while the economy collapses.
Nevertheless, the housing market can remain strong even if the economy is struggling.
Signs of Trouble for the Housing Market
What are the omnimous signs of trouble for the housing market? These are six indicators.
1) Rising Interest Rates and a Greater Number of Houses for Sale
As interest rates continue to rise, this may indicate the impending collapse of the housing market. Several factors, including the current interest rate, contribute to lenders competing against one another to attract buyers.
Given that lenders use similar metrics in calculating interest rates, their rates are often aligned.
If mortgage interest rates increase, buyers will no longer be able to afford to purchase a dwelling at as high a price, resulting in sellers lowering their costs.
Understanding how interest rates work on a mortgage will enable you to anticipate better what will happen next.
Inventories are one of the most significant indicators of a crash. According to the monthly housing supply, it would take approximately nine months for all the listed homes to sell at current demand.
A balanced or healthy market would provide about six months’ supply, so anything less than this would indicate a seller’s market. More than six months of supply would suggest a buyer’s market; Availability and demand are the determining factors.
Obviously, there are more sellers than buyers when the supply of properties increases while the demand does not increase.
2) Macro Economy Experiencing Pains
Housing markets are intensely local, not simply national, and regional variations can be huge, even within a block. Assess the neighborhood you’re looking in at a more micro level.
But housing does not exist in a vacuum, though it may operate independently. Losing a job because of a recession could lead to people being unable to pay their mortgages, and this correlation is inevitable.
In other words, as long as there are jobs, then cash can flow freely, which will benefit the housing market and the entire economy.
3) Risky Mortgages are Common in the Market
We are also likely to see a housing crash when the market begins to expand riskier mortgages and lower credit standards. Easing standards allow low credit quality buyers to make purchases at the exact time house prices are most overpriced.
This scenario led to the credit crisis a decade ago. Before 2007 – 20008, mortgage lenders gave loans to high-risk applicants.
The Dodd-Frank Wall Street Reform and Consumer Protection Act ended several risky mortgage practices that led to the housing bubble.
As lending standards increased, lenders had to verify and document borrowers’ ability to afford the home or a higher credit score. If lenders relax their lending standards to accommodate more high-risk borrowers, it could create a situation that results in an artificially inflated housing bubble.
As a result, you should familiarize yourself with the lending requirements, particularly in the case of higher-risk mortgage loans.
4) After Rapid Growth, Home Prices are Stabilizing or Reducing
If home prices plateau after rising steadily yearly, it could indicate a housing market crash.
Due to its limited quantity (and the fact that not all land is developable), the land is an asset that appreciates over time. Home prices (including land) typically increase by about 4% per year.
If home price levels out or plateaus, it will adversely affect the appreciation of homes and the real estate market. A seller may lower the price of their home if a sufficient number of buyers cannot locate a buyer for the property.
5) People Hesitant to Make a Purchase
In a way, the economy and housing are self-fulfilling prophecies – if people think the housing market is not performing well, the housing market will tank. Purchasing or selling sentiment is relatively indicative of a buyer’s or seller’s market.
A positive outlook on the future encourages consumers to make more purchases, contributing to a favorable economic climate.
Watch consumer “mood swings” over four to five months to determine whether it’s a good time to buy. The consumer is likely to believe that a housing market crash will be a bad time to sell but a good time to purchase since home prices will be below.
A booming housing market is associated with higher consumer confidence and a higher likelihood of consumers saying it is a good time to buy or sell.
6) Agents or Builders are Hesitant to Make Purchases
Consider real estate agents when you look for professionals who can alert you when the housing market is about to crash.
Real estate agents can be your ‘boots on the ground’ and can flag issues as they unfold, their perception of the situation and confidence can be telling.
When it comes to builders, we suggest keeping an eye on price reductions. Builders tend to stay pretty busy during the summer, and as the selling season approaches, prices rise. Take reductions when you see them as a sign that they are nervous.
Final Word: Are We Going to Witness a Housing Market Crash Soon?
There is an understandable sense of worry when you notice one (or more!) of the above signs.
However, there isn’t a lot of significance in finding one of these signs. The housing market could collapse when multiple signs are apparent in a short amount of time.
You have to ask yourself this: Are houses still selling in your market? Is the market fluctuating? Are people trying to sell fast? Are foreclosures on the rise?
You can use these questions to understand how your area’s housing market is doing, but remember, there is no perfect way to predict a housing crash.
Disclosure: The author is not a licensed or registered investment adviser or broker/dealer. They are not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
Tim Thomas has investments in real estate.
Featured image credit: Unsplash.