What is a housing bubble?
A housing bubble can appear in any real estate market. Typically, it means that house prices are high for a period of time, before crashing. To identify the real estate crisis ahead, you need to identify key performance indicators which can reveal a bubble.
Learning from the United States housing bubble
To understand future housing bubbles, we need to understand how it works. Let’s take the US housing bubble of 2008. After the dot-com bubble burst in 2000, and after the 9/11 attack, Alan Greenspan, the Chairman of the Federal Reserve at the time decided to revive the American economy by lowering interest rates from 6.5% at the end of 2000 to 1% in June 2003.
Whenever interest rates are low, there is a risk that house prices grow fast, creating a bubble.
How to identify a housing bubble?
Several economic indicators are here to help. As explained in a wikihow, the easiest thing is to compare the cost of renting to the cost of buying in your community. If buying becomes way more expensive than renting, it’s a strong sign that a bubble is appearing.
To help you, there are 3 useful ratios, which we will explain:
- House price-rent ratio
- House price-income ratio
- Housing prices adjusted to inflation
- Credit to households
House price-rent ratio
The ratio of house prices compared to the cost of rent shows unsustainably high real estate prices. According to VisualCapitalist.com, several countries are now at risk of a housing bubble, using this ratio:
- New Zealand
- Canada
- Sweden
- Norway
- Australia
Indeed, it is normal that house prices go up and down. Yet in Portugal for example, where property prices have skyrocketed recently, rents have increased at an almost identical rate. Therefore, no risk of a big price correction soon.
House price – income ratio
Comparing how much people earn, with how much it costs to buy a property is also useful. Indeed it is a sign of affordability. Again, New Zealand but also Canada and Sweden sadly rank at the top of this ranking. That’s two indicators pointing out that real estate bubbles are likely in these countries.
Real house prices
Finally, real house prices shows whether house prices are growing much faster than inflation or not.
Credit to households
Another interesting indicator is credit to households, showing if people are too much in debt. Yet this needs to be taken with precaution. Indeed, while Switzerland appears #1 as most risky, this could be explained by how the banking system works there. Unlike in most other countries, households can pay only the interests, reimbursing very little capital to the bank. Therefore, we can hardly compare Switzerland to other countries.
Watch out Canada!
If we are to follow this analysis done by VisualCapitalist.com, Canada is in a bad situation. Indeed, it is the only country to appear in the top five ranking for all bubble indicators above.
Is your real estate market going to crash?
CNBC published an article called “European real estate bubble a ‘real possibility’”. Indeed, the euro area is at risk of a new real estate bubble as a result of expansionary monetary policy from the European Central Bank (ECB), Commerzbank analysts have warned.
Yet, then again, differences need to be made between countries. For example, Spanish mortgages are now mostly fixed interest rates, while in Portugal variable interest rates are the norm. Therefore, should interest rates increase, Portugal would be at a higher risk of mortgage default (and housing bubble) than Spain.
In the United States, situation seems to be under control until at least 2026, according to analysts. Yet if we analyze cities, then San Francisco and Los Angeles seem to be at risk, according to UBS Real Estate Bubble Index.
Hong Kong, Munich, Toronto, Vancouver but also Amsterdam and London are identified as most at risk by this UBS bubble index.