Pop Goes the Housing Bubble

Nothing better illustrates government failure and the real estate crisis in an economy than the housing bubble. Nearly a decade after the United States bubble burst spectacularly, setting in motion a global financial crisis, this b-word is still doing the rounds. But what is this housing bubble that the market talks about? How do economists define it? What Is a Housing Bubble?

A housing bubble describes a period in the real estate industry when house prices are over-inflated relative to some benchmark. Usually, factors like a growing disposable income, strong credit growth, low interest rates, loose vetting standards for loans, or maybe something outside the norm - like overzealous investing - work in tandem to drive the house prices up until fewer people can afford what they normally or previously could. But here’s the rub in all this: no one agrees on what that benchmark is or even should be; it could be an estimate of the asset’s value based on a collection of variables that plausibly affect the population growth, tax policy, household size, and household income among others. Or it could be the historical long-run averages, or an estimate of the underlying value of a trend. Housing bubbles affect not only the speculative real estate market, but also residential neighborhoods, personal wealth and the economy at large. They cause a lack of affordability, thus driving more and more people to look for unsavory mortgage programs. However, the bubble itself is rarely a major cause for concern. The problem, of course, is that every bubble eventually pops and this correction is typically violent and harmful, causing severe recessions. The period of above-average levels of house price growth is generally followed by a drop in the prices, back to or lower than the point where the growth started. This drop in the house prices begins at the point where the bubble “pops”. For instance, in a market where prices are Rs. 2 crores per acre, a rapid and unexpected rise to Rs. 4 crores would need to be followed by a hurried return to Rs. 2 crores or lower in a short span to constitute a bubble. This concept is called the Wilson Curve, modelled by Dr. Andrew Wilson. The drop is called the “correction phase” and may take some time to occur. As a result, it’s often difficult to identify a housing bubble until it pops. What Causes Housing Bubbles to Pop? A housing bubble bursts when an increasing housing supply exceeds demand by a large margin. After consistent house price growth, there is a drastic drop because buyers are no longer willing to pay as much for houses on the market. Moreover, many owners may have borrowed more than their house is worth, causing higher debts and a greater rate of foreclosures. This influx of foreclosures drives house prices even lower and floods the market. In short, once the prodigal risk-taking becomes too pervasive and the supply of housing increases as the demand subsides, prices start falling – fast. What is the Present Scenario of the Indian Housing Bubble? Since 8 November 2016, the day Prime Minister Narendra Modi announced this revolutionary step affecting the Indian economy, demonetization has dominated every conversation, making it the most repeated word in the nation. The purpose of the entire exercise was to clean up the system, and that is how it invariably got connected with the real estate industry. But it is high time now to tame the wild rumours and uniformed angst about the impact of demonetization on the real estate sector. It was widely predicted that since cash has traditionally been an integral component of payment in majority real estate deals, the note ban would badly hit the realty sales. However, as against this general perception, the housing prices actually increased across the country during the demonetization quarter, going by the latest House Price Index (HPI) released by RBI, with the figures increasing by 2.3% from 234.9 for the second quarter of 2016-17 to 240.2 in the third quarter (October to December 2016) of 2016-17. Out of the 10 major Indian cities included in the RBI Database, Kanpur witnessed the maximum increase of around 12.2% from 107.8 in Q2 2016-17 to 120.9 in Q3 2016-17. Analysists across the country believe that the increase in question may have happened as the Benami Transactions Act as well as demonetization caused a rush among property holders to register their properties at prices closer to the market rate. This could be attributable to the fact that people did not want to become potential subjects to scrutiny, and would want their property holdings to be legitimate in every respect. This is not to say that the real estate industry has not been affected by the demonetization move; it is just important to understand where the pinch really lies, and where the silver lining is. The sector contributes 5-6% to the total GDP of the country, and any misinformation in a sector that is largely driven by sentiments can lead to chaos. So, is India in the midst of a housing bubble? I will go out on a limb and answer in the negative. Market bubbles are never perfectly clear at any time, otherwise the galloping price increases would stop. However, in my opinion, there are plenty of arguments which show that despite a growing House Price Index and increasing FDI inflows (ranked fourth in developing Asia), the GDP and average per capita income have grown at a slower pace in the nation. As a result, this price growth is unsustainable and will eventually come to an end. Does that mean this is an impending bubble? Or is it a bubble on the verge of bursting? Well, the jury is still out. - Shreeya Jain