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  • Writer's pictureJesse Ledbetter

Stages of a real estate bubble.

There are a few articles out on what a bubble is composed of. Today we'll look at some of the stages required to reach a bubble and see where we are in mid-2021.

Stage 1 - Stable Market

This will be a shock to some, but home values, in and of themselves don't go up. The value of a home, well maintained, goes down very slowly over time. It is only exterior factors that cause a home to increase in value (population/wage changes over time in an area). In Japan, this is well understood and homes depreciate over time, but that land (in shorter supply) appreciates.

Stage 2 - Home Investment

As homeowners have disposable income, reinvestment in the improvement of the home is more likely. This still doesn't increase home values themselves, only the average price of sales. Think of it this way, adding a $20,000 kitchen to your home is likely to add less value than offering the same home for sale with a $20,000 check for kitchen remodeling.

Stage 3 - Home Flipping

As the demographics of an area change, investors may be drawn to an area. These individuals capitalizing on lower condition homes, low cost of materials and low labor costs in a high demand area can achieve sales prices well over their investment.

Stage 4 - Stressed main street buyers

As an area experiences higher and higher demand, the "cost" of not getting a bid may be higher than some are willing to pay. Staying in a hotel for a month is expensive if your lease runs out, etc. In this phase, the home next to the railroad track doesn't look quite so bad. Homes with basements start to look like the basement level is just the same as the above grade. Buyers start to give up on preferences and pay premiums for things that in prior phases they were not. This high demand results in high increases in average prices and attracts those who want to make a quick buck.

In Mid 2021 - we are firmly in stage 4, with record-low inventory and bidding wars common.

Stage 5 - Real estate speculation

In this phase, individuals invest or borrow capital to invest in properties with no plans of long-term investment. 6-12 months to earn 10-30% is better than the stock market in many years. You just have to know when to get in and get out. Speculators can also be flippers, buying at higher and higher levels with the hope of not getting caught holding the asset at the top of the market.

Stage 6 - Profit taking

Neither speculation or house flipping is about investment. These models are all about making money as fast as possible. Lower quality builds next to high tension power lines? Sure, sell it all. Eventually, the money is called off of the table and the artificial upward pressure of these effects is removed.

Stage 7 - Panic

When a sufficient level of artificial demand leaves the market, the first notes of stagnation occur. Homes sit on the market a little longer and sell for a little lower. The main street buyer who bought in the run-up of phase 3-5 now stares at the possibility that their biggest single investment could be upside down and places the home on the market at a discount. And so on, and so on.

There is a very high interest in home flipping in the area that is leading to market data that seems to indicate 15-20% increases in some areas of Richmond (until you look at the data underneath). Some of this house flipping is reaching speculative levels, with long term investors stepping to the side line saying "I can't make money at these levels." We are likely at stage 4.5 if you will in the Richmond area, with the possibility of coming back to more stable growth, but only time will tell.

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