Black and Buono Blog

If you were burned in 2008, the last time the housing bubble burst, you’re probably (and understandably!) gun-shy about jumping into the housing market again — especially if you think your local area could be experiencing another bubble. If you buy during a bubble, overpaying for your home, you might be forced to sell for less than the property is worth — either that or stay put longer than you’d like until you build up enough equity to sell. So if you’re thinking of buying, it’s important to have a sense of the signs that point to a real estate bubble. Here are five of them.

1. Shaky loans are common

As we learned from the 2008 recession, subprime lending (lending to anyone with a pulse) is not sound practice. And we have made changes. Credit remains relatively tight.

Yet the U.S. government still backs loans that some might consider risky, particularly ones that require only a 3.5% down payment, which the Federal Housing Administration (FHA) offers. Before you get too alarmed, keep in mind that the FHA has been helping people become homeowners since 1934. The underwriting standards are higher with FHA loans than with some of the subprime low-down-payment products offered in the early 2000s.

2. There’s lots of leverage

When you take out a mortgage, you’re leveraging your money — the smaller the down payment you make, the more you have leveraged the deal by using the lender’s money to make the purchase. A bubble means lots of leverage. And this [current] cycle has been remarkably devoid of leverage.

When housing prices are rising and your salary isn’t, you’re left with two options: continue to rent, or buy a house you can barely afford. If you think your market is in a bubble, you might want to wait to buy, especially if you’re really stretching to make ends meet.

Review the mean income levels and employment levels compared to real estate prices for signs of discord. Indicators of a local real estate bubble are asset values exceeding the local market’s capacity to absorb prices. When home prices rise faster than salaries it could be the sign of froth in the market.

A rapid run-up in prices that don’t match wage growth leads to discussions about bubbles. As long as credit conditions from bank lenders are tight, you won’t have runaway price inflation.

So what do you do when affordability isn’t improving in pricey markets like New York, NY, San Francisco, CA, Los Angeles, CA, or any other high-cost urban market? Buy in the burbs. The market is booming in the outlying suburbs.

4. Foreign demand slows

Miami, FL, might not be experiencing a bubble, but this city is in for a serious correction. Since it is an international city, when foreign national buyer demand slows, our markets suffer.  And that’s what’s been happening in Miami. To make matters even more difficult for Miami’s housing market, throw in the Zika virus, which affected two of Miami’s key tourist areas: Wynwood and Miami Beach. They were declared Zika zones by the [U.S. Centers for Disease Control and Prevention]. That may have been the straw that broke the camel’s back in a market that was already slow, as it diminished tourism and buyer demand. (The good news? Those areas are no longer Zika zones.)

5. Interest rates rise

If people are on the fence about buying a home, the fact that interest rates are really low might be enough to push them over to the house-buying side. But as soon as interest rates rise, demand for housing could fall. If interest rates increase by 1%, all the houses suddenly become unaffordable, and you’ll see a sinking housing market because they equilibrated at these historically low interest rates.

6. When there are no signs

Of course, you might think your market is (or isn’t) in a bubble, but you could be wrong. The problem with bubbles is that we don’t know them when we see them. San Francisco, CA, for example, a hugely unaffordable city for most people, isn’t in a bubble just because prices are high. Bubbles do not refer to rapid price appreciation. They refer to unsustainable rapid price appreciation. [The market] is unsustainable because fundamentals do not support the appreciation.

The bottom line is, it’s difficult to know whether it’s really a bubble. If homeowners buy a house that works for their family and that they can afford over the long haul, they will have made a decision that benefits them every day, even if real estate prices drop significantly. But heed the warning: If homeowners instead buy a house that is a financial stretch in the belief that it will appreciate down the road and fund their retirement, there is a good chance that they have set down a road to ruin.

For assistance with buying or selling a home, contact Black and Buono.

Forbes