How to Avoid Becoming a Victim of a Real Estate Bubble

Hany Constantin
27/03/2019 2:46:32
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The probability of experiencing a Real Estate Bubble in Davao City.

What is “Real Estate Bubble”?

A housing bubble is a run-up in housing prices fueled by demand, speculation and exuberance. Housing bubbles usually start with an increase in demand, in the face of limited supply, which takes a relatively extended period to replenish and increase. Speculators enter the market, further driving up demand. At some point, demand decreases or stagnates at the same time supply increases, resulting in a sharp drop in prices — and the bubble bursts. Reference: Investopedia

Housing bubbles may occur in local or global real estate markets. In their late stages, they are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This may be followed by decreases in home prices that result in many owners finding themselves in a position of negative equity—a mortgage debt higher than the value of the property. Reference: Wikipedia

Bubbles in housing markets are more critical than stock market bubbles

The United States and China Real Estate Bubbles

The United States housing bubble was a real estate bubble affecting over half of the U.S. states. Housing prices peaked in early 2006, started to decline in 2006 and 2007, and reached new lows in 2012.

The collapse of the U.S. housing bubble had a direct impact not only on home valuations, but mortgage markets, home builders, real estate, home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks, increasing the risk of a nationwide recession.

The bursting of the housing bubble in Mid 2000 sent the United States into the worst recession in decades.

For three decades, China had been nothing short of a financial miracle, one sector the Chinese authorities concentrated on was real estate and construction. That created the largest housing bubble in human history. If you go to China, it’s easy to see why there’s all the talk of a bubble. The most populated nation on Earth is building houses, districts and cities with no one in them.

The government spent some $2 trillion to build not only houses but giant cities. The government get these cities built as a way of keeping the economy growing. The assumption is “if you build it, they’ll come.” But no one come.

Are We heading for a Housing Bubble in Davao City?

A Real Estate Bubble is a type of economic bubble that occurs periodically in local or global real estate markets, and typically follow a land boom. A land boom is the rapid increase in the market price of real property such as housing until they reach unsustainable levels and then decline

Constantin Design & Build suggest that a Real Estate Bubble is soon entering in Davao City. A noteworthy drive by developers to build high end condos in high risers dumping on the market a significant number of small apartments (shoe box size) made accessible via attractive financing schemes and meant for the rental market not “buying to reside”.

A large number of those apartments are bought by speculators and investors planning to rent the units or re-selling them at a premium. High end condos for rent have been gradually flooding the Davao market driving the occupational rate down.

The ownership ratio is the proportion of households who own their homes as opposed to renting. It has risen steadily in Davao recently. A high ownership ratio combined with an increased rate of lending may signal higher debt levels associated with bubbles.

This invite us to consider the following indices:

The price-rent ratio is the average cost of ownership divided by the received rent income (if buying to let) or the estimated rent (if buying to reside)

The gross rental yield, a measure used in the United Kingdom, is the total yearly gross rent divided by the house price and expressed as a percentage Reference: Wikipedia

Both indices when evaluated in the Davao City Condo context indicate an alarming slide of the Condo market in Davao City towards a Bubble.

How to Avoid becoming a victim of a Real Estate Bubble

Common sense dictates adopting sound financial behavior:

  1. Purchase a home “to reside”
  2. Limit your debt to personal income ratio resulting from acquiring a home to 30%
  3. Investigate thoroughly the rental market before venturing in committing to purchase condo units with view to rent even if the financing scheme offered by the developer is enticing.