Is there an Asset Bubble in the Housing Market?

Some evidence has shown there may be an asset bubble in the housing market. What is an asset bubble? Good question! An asset bubble exists if prices are high today because real estate investors believe they will continue to rise the next day- not because fundamental factors justify the rise in prices. As we have seen in historical events, there are several instances of asset bubbles as well as the big pop!

Housing Market Bubble Timeline

One historical asset bubble that was quite dramatic is The Dutch Tulip bubble. Soon after tulips were introduced to Europe, they became prized possessions of the wealthy. Because these flowers could be bought and resold within days for a large profit, the Amsterdam Stock Exchange began trading interests in them. Notaries started specializing in recording these tulip transactions. It is noted that in its peak of the bubble, the bulb sold for well over 34,000 dollars in today’s market.

As time went on, investors would begin to liquidate their interests in tulips, the supply dramatically increased, and for a duration period of six weeks the price of tulips plummeted 90%! The government then tried to limit the following chaos by nullifying all tulip contracts and declared tulip trading as a form of gambling. Today rare tulip bulbs sell for less than fifty cents per tulip, thus prices never recovered after the bubble burst.  The question we are facing now is will the housing market bubble burst?

Housing Bubble Expectations

Some parallels to be noted which encourage speculation that we are experiencing an asset bubble in the U.S. real estate market is as follows. The U.S. economy entered a recession in 2001. The increased demand for a lower mortgage rate helped inflate the price of houses. Increasing prices got rid of some possible buyers with even low mortgage rates. Financial institutions began pushing adjustable mortgage rates and in doing so qualified more houses for mortgages, increased demand for houses, and helped to inflate housing prices.

Near the end of 2004, mutual funds and stocks were worth 21% less than five years prior. Since 2002, California housing prices have seen a rise in 71%. High returns attract speculators. In 2004, an estimated 23% of homes purchased were bought by real estate investors. Almost 13% if the additional homes bought during this time, were bought as second homes. People who do not live full-time in a home are more inclined to sell quickly if prices decline. If supply increases quickly, there will be a continued downward pressure on home prices.

Housing experts once forecasted that the housing bubble may pop. UCLA’s Anderson Forecast warned that the peak was near and the resulting slowdown would weaken economic growth- and possibly cause a recession- for the next two years in 2005. Their song has changed since then and in the latest report there is no convincing evidence of a slowdown in the grand scheme of things. Location will always be the most important factor!