For those who are viewing the New York City real estate surge, you may be wondering if it is the sign of a boom in the industry or simply a bubble that will soon be popped. Naturally, there are fears that an NYC real estate bubble is forming which has led some investors and potential home buyers to be more cautious during this time.
Actually, practically every time the real estate market turns around and heads upward there are fears that the trend will not last. So, it is understandable that there are people who are skeptical of the long term strength and durability in the real estate market. It is important to understand the fundamentals of the marketplace and whether this current rise is built on true economic growth or merely wishful thinking that will soon collapse.
What is a Real Estate Boom?
By definition, a boom is defined as a 30% or greater increase in home prices as adjusted for inflation over a three year period. This is the origin of the term “1/3 in 3 Rule” which indicates that home prices ,which are rising a sure sign that people are buying. Conversely, a bust uses the 15/5 Rule, which is a reduction in home prices by 15% over a five year period.
Currently, the signs are pointing to a boom in the real estate market not only in New York City, but across much of the country as well. There are several reasons for this, but arguably the most important is that we are finally emerging from the housing crash of 2008. That crash was caused by factors that are now subsiding with demand for housing on the rise once more.
However, is there a difference between a true boom in the real estate market and the creation of a bubble much like the one that preceded the 2008 housing crash that cause prices to plummet into the depths for several years?
The chart shows an inflation-adjusted index of American housing prices going back to 1890. There are periods where the real value of homes fell, such as World War I and the Great Depression. And there are periods where homes appreciated nicely, as in the 1970s and 1980s real estate booms.
The answer is that there are factors which separate a boom from a bubble and that those who are looking for a new home or residence can take into account when they are shopping at the market.
The Signs of a New York Real Estate Bubble
There are a few signs that people should look for when evaluating the current market conditions and comparing them to the boom years where there was robust growth that lasted for a long period of time. To understand the differences should help in choosing which type of real estate market we are currently experiencing
Rapid Increase in Property Value: A bubble is created when prices for property start rising quickly due to artificial means. For example, one of the reasons for the housing bubble that preceded the 2008 crash was that mortgages were being obtained by those who normally would not have qualified. This action led to an artificial rise in the prices of homes because the demand exceeded the supply. In 2008 when many of the people who stopped paying on the mortgages they couldn’t afford in the first place, the real estate market collapsed and nearly took the US banking system with it.
Today, the rise in value that is seen in the NYC area does not denote that a bubble is being formed. With new rules and regulations governing mortgages combined with the slower, more gradual rise in value of properties, the indications are that the rise in value is due more to natural supply and demand factors. With the unemployment rate decreasing, and more jobs becoming filled, the rise in property values is reflecting the greater spending power of the NYC residents.
Low Supply of Homes: Generally speaking, when the supply of a product or item is low, the prices become artificially high because the demand is excessive. Once the supply starts catching up to the demand, the prices suddenly drop which may cause a cascade effect depending on the product, its importance and how it influences the price of other products.