The 5 Indicators of a Real Estate Crash
At the beginning of 2020 people quickly began speculating that a real estate market crash was inevitable. There are a lot of indicators of real-estate crashes, but this year hasn’t really signaled a hard crash yet in my opinion.
In this article, we are going to talk through the 5 indicators of a real estate crash in your local market.
These are not macro factors and not all-inclusive, as there can always be outside factors like in 2008 when the mortgage industry created a disaster. Generally speaking, these five market indicators will be able to help you predict when you are at the peak or the bottom of a market cycle.
By studying these five indicators in your local market, you will be able to predict when the real estate cycle is going to change directions.
Ultimately, the better you’re able to predict these cycles, the more money you can make as an investor.
Keep in mind that every market in the nation is different, and these are local indicators. These data points are extremely helpful in understanding what your local market will do in the future.
That being said, these are just indicators – not a crystal ball – so do your due diligence as always.
1. Falling Existing Home Sales
The first indicator of a real estate crash is the current existing-home sales.
The law of supply and demand drives most economic markets, and this is especially true with real estate.
If there are more homes on the market than there are buyers, the market slows down and homes start sitting on the market for longer periods of time before they sell. As home sales slow down, buyers are able to offer less money and prices start to decline. If there are way more houses on the market than there is demand, they are deemed less valuable.
Conversely, if there are fewer homes on the market than there are buyers, the market speeds up and homes start flying off the shelf much faster. As home sales speed up, sellers are able to demand more money for their homes, and buyers begin to create a bidding war amongst themselves. If there are fewer houses on the market than there is demand, they increase in value.
One more time:
More houses (supply) for sale than buyers (demand) = less valuable real estate. In real estate, this is referred to as a buyers’ market.
Fewer houses (supply) for sale than buyers (demand) = more valuable real estate. In real estate, this is referred to as a sellers’ market.
You should pay attention to the days on market (DOM) metric in your local area and determine whether it is heating up or cooling off. For example, when the DOM gets longer and longer, it is a sign of a coming real estate market crash.
2. Slowing of Building Permits Being Pulled
There are a couple of reasons that building permits are a good indicator of a real estate crash.
For one thing, the construction industry is one of the largest industries in the nation. If the construction industry is booming, that means employment is high and the economy is doing well.
For another thing, developers pay a lot of attention to the supply and demand of a market. When developers stop developing, builders stop pulling building permits, and the real estate market begins to slow down.
When the real estate market is hot, builders are pulling permits. When the market begins to slow down, permits will be less frequently pulled.
Pay attention to how many building permits are being pulled year over year and quarter by quarter. You can track this information through your local county records. As builders begin to pull fewer permits, it is an indicator of a potential real estate market crash looming.
3. Mortgage Defaults on the Rise
Mortgage defaults are an important indicator of market crashes for two reasons:
- Rising mortgage defaults can be followed by rising foreclosures, which leads to more issues in the real estate market.
- Mortgage defaults are also an indicator of the overall health of the economy. If unemployment is rising and people are unable to afford their mortgages, it is probably a sign of coming trouble in the broader economy.
When you fail to make your mortgage payments, the bank can put your loan in a default status. This can happen immediately after you miss a payment or months later depending on your loan terms and state laws.
After your mortgage ends up in a default status, you will need to catch up on payments quickly or the bank can foreclose on your property, which leads us to the next indicator of a pending market crash.
4. Foreclosures Rising
Foreclosures were made “popular” by the 2008 real estate crash. This crash was caused in a large part by banks lending money to people who shouldn’t have qualified.
Foreclosures occur when a homeowner (borrower) goes into default on their mortgage and is unable to catch up on payments. In this situation, the bank may be forced to foreclose on the mortgage and repossess the home.
Nobody wins when the bank needs to foreclose on a property for several reasons. Usually, this happens when the homeowner can’t sell the house for more than the remaining mortgage amount. If they could, they would sell it instead of going through a foreclosure.
Also, the bank doesn’t want to own your home and will most likely turn around and sell it as quickly as possible in order to get it off their balance sheets.
Pay attention to rising foreclosure rates because they usually predict a market downturn. More foreclosures will increase the supply of housing and lower the value of homes around them.
5. Interest rates
Interest rates are a great indicator of the amount of money people will be able to borrow.
As interest rates rise, homeowners will be able to borrow less money.
As interest rates drop, homeowners will be able to borrow more money.
Therefore, the lower interest rates drop, the more money homes will be able to sell for. As people are able to pay more and more for a house, prices will continue to rise.
Likewise, when interest rates increase, homeowners will be able to afford less house than they would have when interest rates were compressed (low).
Interest Rate Caveat
It is important to note that interest rates are not recognized as a determining factor for which way the market is going. Instead, they act as an accelerator or decelerator for whatever direction it is already headed.
For example, if home sales and building permits are high with minimal defaults and foreclosures in the market, then the market is most likely increasing in value. If interest rates drop, the market will rise even faster. However, if interest rates increase, the market will still rise but a little slower.
Likewise, if the market is trending downward, dropping interest rates will slow the drop but not stop it, and rising interest rates will accelerate the downward trend.
For this reason, I don’t view interest rates as the end all be all of the market cycles, but they are very helpful to keep your eye on.
Indicators Tell “What” Not “Why” There May be a Real Estate Crash Looming
…but all you care about is the “what.”
In case that wasn’t as clear as I wanted it to be, let’s break it down a little bit.
If the 5 indicators we discussed all signal that the market is about to drop, it may not give you any clue as to why they are signaling that way. Ultimately, you don’t need to play detective and try to figure out why the market is signaling a crash…you just need to know that it is.
Also, these indicators don’t mean an immediate correction—they just signal that it may be coming in the near future. Also, it is possible that some indicators will pop up and then correct themselves. But if all of these indicators signal a change in the market cycle, you would do well to pay attention.
Indicators of a Real Estate Crash
To be clear, these indicators are not a guarantee that a market crash (or rise) is coming. They are simply indicators you can, and probably should, track in your local market in order to stay ahead of the market cycle.
I promise that you would much rather be anticipating a crash before it happens than not be aware of a crash until it is too late.
The indicators of a real estate crash discussed in this book are taken from the book Timing the Real Estate Market: The Campbell Method, which I am currently reading. I got to hear Robert Campbell speak at an NSDREIA (a meetup in San Diego County) meeting earlier this year and found what he had to say intriguing!
Here is more information on macro and micro factors to look at when analyzing a real estate market!