If it bursts, will houses ever regain their current value?
In: Economics
Every asset has a realistic / intrinsic value. So, for example, one can say that the intrinsic value of a house can be a summation of “cost of the land on which it is built + cost of building, furnishing and other expenses to make the house livable + a “reasonable” profit margin (corelated in some way to my finance cost) in case I wish to sell”. Now there are instances when some houses get sold for 2x, 3x times of their intrinsic value (within a couple of years). This does happen in reality – sporadically in some pockets of the market every once in a while. When this starts happening across all locations in the country / across all categories of houses ***and there are still buyers available who keep buying them at those abnormal prices*** – ***consistently*** – ***for few years*** – then it is fairly safe to say that a housing bubble has been created.
If you see the above example – or for that matter any transaction – there has to be a seller and a buyer. If the seller has an unrealistic expectation of sale price for his house and there are multiple buyers who are willing to pay for it (for whatever reason – they may have an urgent need or may have disposable income or may have insider information about the area and expect a price increase soon or are plain dumb and dont know the market or are motivated by FOMO etc.) – then housing bubble will get created. Repeated “inflated” transactions reset and increase the “expectation benchmark” of the area – thereby giving more air to the bubble.
The bubble keeps blowing up till “new money” keeps coming in and paying off the sellers (Its like a MLM scheme where the new entrants subsidize the older players). Soon after the “new money coming in” stops – the bubble bursts. The prices dip down to the other extreme where houses will be sold at prices “lower than their original intrinsic value”… and slowly new buyers start coming and prices creep upwards – slowly. And the cycle repeats again after a few years…
Whether we are in a housing bubble or not – can be judged by simply looking at your neighbourhood / county / state / country and see if this is a common phenomenon where housing prices have risen by “many tens of percent every year” over the last few years consistently (and who is buying those houses – are they landlords for renting or families for staying). Based on the observations (and few more indicators) you may be able to guage whether we are in a housing bubble or not.
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