A housing bubble is when housing prices increase due to demand, speculation and spending, until the housing market collapses. The U.S. experienced a major bubble in the mid-2000s.

This trend will usually start after an increase in demand. Supply is low, and there is a large period until the supply can catch up to the demand. Speculators will pump money into the market until demand drops or pauses at the same time that supply increases. This supply and demand dynamic will cause the bubble to burst and prices to drop rapidly.

Just like any bubble, a housing bubble is a temporary event that can last years. Oftentimes, a housing bubble is driven by something abnormal like unusual levels of investment, manipulated demand and — as was the case in the mid-2000s housing bubble — unregulated markets. All of these factors lead to an increase in demand without increasing the supply, causing home prices to become unsustainable.

Housing bubbles majorly affect people from all walks of life. Of course, they cause real estate to crash, but they are also one of the leading causes as to why people lose their life savings.

Real estate markets are less likely to fall victim to bubbles as other financial markets. This protection is due to the large fees associated with owning properties. However, it is still very possible.

Because multifamily apartment buildings — and some clusters of single-family rentals — are considered commercial real estate assets, the residential housing collapse had a huge impact on commercial real estate financing as well.

What Did We Learn From the Mid-2000s U.S. Housing Bubble?

Following the dotcom bubble of the late 1990s, many investors moved their money into residential and commercial real estate. Simultaneously, the U.S. Federal Reserve cut interest rates and held them down as a way to battle the light recession after the dot com bubble burst. Money flooded into the housing market as the U.S. government made policies that encouraged homeownership.

All of these factors combined caused home prices to rise and homeownership mania to grow to unsustainable levels. Between the years of 2000 to 2007, the median sales price of homes skyrocketed by 55%. This increase led to speculators entering the market, flipping houses for thousands of dollars in only a couple weeks.

By 2006, interest rates started to crawl upward and adjustable-rate mortgages reset at higher rates. This climb created an environment that was too dangerous for demand to stay at such a high level, and investors stopped purchasing houses. Housing prices began to nosedive, declining 19% from 2007 to 2009.

Just like the tech bubble, the housing bubble was characterized by a rapid increase in housing prices due to many external factors. As the bull market continued, investors entered the market as speculative investments. As soon as the factors that caused the bubble started to adjust, the bubble burst.