BEATING A HOUSING BUBBLE

 

How do you recognize signs of a housing bubble? 

That’s the question many prospective homebuyers -- and current homeowners -- are asking themselves these days. As home prices rise at 20% annual rates in some areas, many wonder if residential real estate is falling prey to the same kind of wild speculation that has led to the stock market’s spectacular downfall.

Any time there’s a disconnect between prices and the underlying value of homes, as measured by their market rents, there’s the potential for a bubble.

If home prices are rising much faster than rents, that’s a strong indication a bubble is forming.

If home prices are rising while average rents are falling  the bubble is pretty much unmistakable.

What could trigger a collapse?
Identifying a bubble and actually predicting when it will burst are two very different matters, of course.  The nature of a bubble is to feed on itself, with rising prices convincing more and more investors that prices can only continue to rise.

Higher interest rates could be enough to knock many of the nation’s real estate markets off their perches. Economists say hard shocks to local economies – such as the drop in oil prices that devastated USA in the 1980s or the collapse of the defense industry in USA in the early 1990s -- will be the trigger. Still others dismiss any talk of a bubble, noting that a relatively strong economy could keep prices on the rise for years.

How to reduce your risk?
So what should you do if you’re thinking of buying a home in a market that seems overvalued?  The possibility of a bubble alone should keep you from becoming a homeowner. After all, prices could continue to rise for many years, or values could plateau rather than falling. Even if they do drop, who’s to say you would be willing to buy then? Falling markets often scare buyers even more than rising ones, and the fear could keep you from buying for years.

If you’re financially ready to buy a home and willing to stay put for awhile, you can reduce your risk from a real estate bubble in the following ways:
Look for undervalued properties. Even in the wildest markets, there are ugly ducklings -- flawed homes that others overlook. If the defects are fixable, you might be able to get a relative bargain and be in better shape than your neighbors should prices fall.
Buy defensively. Homes in good neighbourhoods with good schools tend to hold their values better, real estate agents say. Single-family homes usually fare better than flats, which often are the first to lose value in a real estate recession and the last to regain it during a recovery.
Stay put. Find a home you can live with for awhile. The people who get hurt the most during real estate recessions are those who are forced to sell, usually because of a job change or because they couldn’t really afford the home in the first place. If you can hang on to a home for five to 10 years or more, you improve your chances of being able to ride out a downturn and at least break even when you sell.

 

 

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