Stock market investors accept the risk that prices will fall from time to time—sometimes severely—but people who buy a🍸 house may assume that the value of their home will never decrease by much.

They're not wrong. Historically, the housing market has not suffered from the frequent price bubbles and extreme volatility seen in other investments. However, housing markets can experience periods of irrational exuberance that lead to real estate bubbles, followed by lower demand and lower prices when the bubble bursts.

A decision to buy or sell a home is far more fraught than trading stocks or bonds. However, some of the same principles apply, such as looking at long-terඣm averages rather than short-term ups and downs.

What Is a Housing Bubble?

A housing bubble, like a sharp increase in the price of any product or service, generally begins w🌱ith a jump in demand and a limited amount of inventory.

The demand grows as more buyers jump into the market. Then, the speculators show up, snapping up investment properties and flipping fixer-upp🍸ers.

Wജith limited supply and so much new demand, pജrices must go up.

Eventually, prices can ri🔥se to an unsustainable level. Home prices become unaffordable to the average buyer or even the above-average buyer in that region.

A bubble is a temporary event. In the stock market, they happen fast and can burst even faster. A housing bubble can persist for several years, according to the 澳洲幸运5官方开奖结果体彩网:International Monetary Fund (IMF).

But at any time, ext😼ernal factors can flatten a bubbly housing market. An increase in mortgage rates puts monthly carrying costs out of the reach of more people. An economic downturn causes higher unemployment, taking more people out of the pool of homebuyers. Speculators get nervous and stop looking for houses to flip.

What Causes a Housing Market Bubble?

The price of housing, like the price of any product or service in a 澳洲幸运5官方开奖结果体彩网:free market, is driven by the 澳洲幸运5官方开奖结果体彩网:law of supply and demand. When demand🌊🍨 increases or supply decreases, prices go up.

In the absence of a natural disaster, which can decrease the supply of homes, real estate prices rise when demand outpaces supply. The supply of housing can be slow to react because it takes a long time to build or fix up a house. In some urban areas, there simply isn't any more land to build on. This lack of available land can be compounded by local ordinances that forbid building multi-unit housing such as apartments or condominiums in favor of single-family homes,

So, if there is a sudden🦩 or prolonged increase in demand, prices are sure to rise.

What Drives Housing Demand

Increased demand doesn't occur in a vacuum. There are usually a number of factors at work:

• A rise in general economic activity and increased prosperity puts more disposable income in consumers' pockets and encourages homeownership
• A demographic segment enters the housing market
• Low mortgage rates make homes more affordable
• Mortgage products with innovative features like low initial monthly payments make home ownership more accessible
• Easy access to credit—often with lower 澳洲幸运5官方开奖结果体彩网:underwriting standards—brings more buyers into the market
• Lenders want more mortgage business to feed Wall Street's demand for high-yielding structured 澳洲幸运5官方开奖结果体彩网:mortgage-back securities (MBS)
• Loose lending standards make it easier to get a mortgage
• Excessive risk-taking by mortgage borrowers
• Speculative and risky behavior by home buyers and investors fueled by unrealistic and unsustainable home price appreciation estimates

Some or all of these variables can combine to cause a housing market bubble to form. Indeed, all bubbles show the 💞same general pattern: an uptick in activity and prices precedes excessive risk-taking and speculative behavior by all market participants—buyers, borrowers, lenders, builders, and investors.

Why Does a Housing Bubble Burst?

A bubble finally ꦏbursts when excessive risk-taking becomes pervasive and prices no longer reflect anyt💧hing close to fundamentals.

In the housing market, this will happen when builders continue to build in response to demand that has started tapering off. In other w🗹ords, demand decreases while supply increases. The inevitable results are a slowdown in sales and a decline in price appreciation.

That's not the end of the cycle. As sales slow and prices stop rising, the realization of risk reverberates through the market. That realization could be precipitated by a number of things:

• An increase in interest rates puts homeownership out of reach for more buyers and, in some cases, causes financial distress for current homeowners. This often leads to defaults and 澳洲幸运5官方开奖结果体彩网:foreclosures, which eventually add to the supply of homes available.
• A downturn in general economic activity leads to less disposable income, job losses, and fewer job openings, which decreases the demand for housing. A recession is particularly dangerous.
• Demand is exhausted, bringing supply and demand into equilibrium and slowing the rapid pace of home price appreciation.

At that point, the cycle coul༒d be completed. Supply and demand have achieved equilibrium and prices have leveled off. But it can get worse.

As the mood of the market changes, credit standards are🗹 tightened, demand decreases, supply increases, speculators leave the market, and prices start to fall.

What to Do in a Housing Bubble

If you already own a house in an area that is experiencing soaring home prices, you'll be tempted to sell. Just remember, unless you're planning to move to a less expensive region, downsize, or rent, you're jumping into the bubble. You'll be out there competing with the rest of the homebuyers in a possibly inflated market.

If you're in the market for a home, you might consider putting it off for a while. You could wind up overpaying.

The 2007–08 Housing Market Crash

In the mid-2000s, the U.S. economy experienced a widespread housing bubble that helped bring on the 澳洲幸运5官方开奖结果体彩网:Great Recession.

It took several years to develop. Following the 澳洲幸运5官方开奖结果体彩网:dotcom bubble, values in real estate began to creep up. Low interest rates, relaxed lending standards, and low down payment requirements encouraged people to borrow beyond their means. This drove home prices up even more.

But many speculative investors stopped buying because the risk was getting too high. Others caught on and got out of the market. And when the economy took a turn for the worse, many subprime borrowers found themselves unable to pay their monthly mortgages or refinance them.

This, in turn, caused prices to drop. Mortgage-backed securities were sold off in massive quantities, while mortgage defaults and 澳洲幸运5官方开奖结果体彩网:foreclosures rose to unprecedented levels.

What Is Mean Reversion?

Too often, homeowners make the error of assuming that recent price performance will continue into the future. They'd be better off considering long-term rates of price appreciation and the potential for mean reversion.

The laws of physics state that when any object which has a density greater than air is propelled upward, it eventually returns to earth because the forces of gravity act upon it. The laws of finance similarly s𒀰tate that markets that go through periods of rapid price appreciation or depreciation will, in time, revert to a price point that puts them in line with their long-term average rates of appreciation. This is known as reversion to the mean.

Prices in the housing market follow this tendency for mean reversion, too. After periods of rapid price appreciation, or in some cases, depreciation, they revert to whe✃re their long-term average rates of appreciation indꦡicate they should be.

In home prices, mean reversion can be either rapid or gradual. Home prices may move quickly to a point that p꧃uts them back in line with the long-term average, or they may stay constant until the long-term average catches up with them.

The theoretical value shown above has been derived by calculating the average qua𒁏rterly percentage increase in the Housing Price Index from the first quarter of 1985 through the fourth q🌱uarter of 1998. That is the approximate point at which home prices began to rise rapidly above the long-term trend.

The calculated average quarterly percentage increase was then applied to the starting value shown in the graph and each subsequent value to derive the theoretical Housing Price Index value.

Price Appreciation Estimates

Home buyers tend to use recent price performance as 澳洲幸运5官方开奖结果体彩网:a benchmark for 🅠what they expect over the next several years. Based on this unrealistic estimate, they take excessive ri𝓰sks.

Excessive risk-taking is usually associated with the choice of a mortgage♑, and the size or cost of the hom🃏e the consumer purchases.

Relatively short-term mortgage products are heavily marketed to consumers who take this risk. They choose these mortgages based on the expectation that they will be able to 澳洲幸运5官方开奖结果体彩网:refinance in a few years because of theꦡ increased equity they will have in their homes.

Recent home price performance is not, however, a good prediction of future home price perfor꧅mance. Homebuyers should look to long-term rates of home price appreciation and consider the financial principle of mean reversion when making important financing decisions. Speculators should do the same.

Taking risks is not inherently bad. The key to making a good risk-based decision is to base it on a financially sound estimate. This is especially applicable to the largest and most important financial decision♑ most people make—the purchase and financing of a home.

The Bottom Line

A simple and important principle of financeღ is mean reversion. While housing markets are not as subject🌳 to bubbles as some assets, housing bubbles do occur.

Long-term averages provide a good indication of where housing prices will eventually end up during periods of rapid appreciation followed by stagnant or falling prices. The same is true for periods of below-average price appre𒀰ciation.