Behavioral Thoughts on Home Buying

Robert Shiller of the infamous Case-Shiller index has a particularly interesting piece in the NYT. Instead of hammering on numbers, he takes a look at the psychology of home buyers and sellers and why that might affect home prices for some time to come.

Shiller examines the behavioral biases that lead people to “irrationally” hold onto houses during a period of declining values. The concluding paragraphs are thought provoking:

For this reason, not all economists agree that home price declines are really predictable. Ray Fair, my colleague at Yale, for one, warns that any trend up or down may suddenly be reversed if there is an economic “regime change” — a shift big enough to make people change their thinking.

But market changes that big don’t occur every day. And when they do, there is a coordination problem: people won’t all change their views about homeownership at once. Some will focus on recent price declines, which may seem to belie any improvement in the economy, reinforcing negative attitudes about the housing market.

Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.

I say it’s thought provoking because when you look at the recent frenzy in the lower priced end of the housing markets, it’s hard to come up with a theory that squares with Shiller’s ideas. Unless you are of the opinion that the drastic decline in prices constitutes an economic “regime change.” Certainly, there hasn’t been any fundamental shift at all in the general economy that has prevailed in this sudden shift from a buyers to sellers market. So what might be driving it?

The only plausible theory I can come up with is that the buyers perceived an exceptional opportunity to purchase housing at favorable prices. Did they do so on the assumption that prices were about to begin a march back? Is the meme that you can’t lose money long term buying real estate so firmly ingrained that no amount of empirical evidence to the contrary will diminish it or are they simply grabbing an opportunity to buy shelter?

What I haven’t seen and would like to see is some work done on the extent to which the prospect for future appreciation drives home buyers, particularly first time home buyers. It might well be that there is a fundamental drive to ensure one has a roof over one’s head that trumps a lot of other considerations.

Comments

[ATLBob:]

"...The only plausible theory I can come up with is that the buyers perceived an exceptional opportunity to purchase housing at favorable prices. Did they do so on the assumption that prices were about to begin a march back? Is the meme that you can’t lose money long term buying real estate so firmly ingrained that no amount of empirical evidence to the contrary will diminish it or are they simply grabbing an opportunity to buy shelter?"

I think you're on track with the exceptional opportunity and favorable price concept, and that the buyers are planning to stay there for awhile (shelter) or they are longer-term speculators (not flippers) who can afford to wait for the real estate market to appreciate The reality is that sellers discovered in a most painful way that you can lose money on anything (including real estate) if you can't afford the luxury of waiting for the time when it's recovered its value.

Jun 07 11:07 AM

[LarryG:]

I deal in the higher end of the real estate market, the vacation and retirement side. The psychology among baby boomers is odd but understandable. Those with equity in their homes and a long-term plan to move to warmer climes are holding off because they just cannot accept a true market price (not when their neighbor got 20% more 18 months ago). So they are denying themselves a lower cost of living, the opportunity to downsize (and pocket the difference in real estate costs) and the realization of their dreams of retirement. Yet sheer demographics and other market forces indicate that, in general, prices in favorable southern climes will increase faster than those in the north. Therefore, the longer these boomers wait, the less buying power they will have.

Jun 07 12:09 PM

[Sean in CA:]

It's a "sellers market" now? If you're a drug dealer maybe.

Jun 07 12:23 PM

[Doug Francis:]

When I first meet with buyer clients today, I emphasize that buying a home should be looked at with a five-year perspective... as we see drops down and pops up. Back in the mid 1990's, people were shocked when I would state 1-3% annual appreciation, but that whole theory was thrown out starting in 1998 when many people where I work outside D.C. were flush with profits from IPO's and wanted to buy homes at any cost. (they needed tax deductions)

American's are optimists by birth!

Jun 07 12:30 PM

[nym:]

The notion that you've got to buy now before prices go higher is what got us here in the first place. The bell has rung for another round.

Jun 07 09:34 PM

[dondon:]

Besides shelter and possible future appreciation, the main reason to buy a house is the mortgage tax deduction. At some point in order to pay for the trillions in debt, taxes are going to have to go up for just about everybody. The government took away the deduction for credit card interest and will soon declare the mortgage interest deduction null and void. It may happen gradually starting with the wealthy but eventually it will move down the line to the middle class. When that happens look out below.

Jun 08 03:26 AM

[evergreen16:]

After reading few of these fear-and-gloom comments, one has to wonder - who are those kids writing these comments?
Are they just bored high-school kids that just have fun firing back at peple without the ability to understand the subject at hand?
It's funny how they think they are the smartest, untill they eventually grow up and realize they were dead-wrong.

Jun 08 12:32 PM

[Radardoc:]

It seems to me the "fear and gloom" comments are those backed up by data, and the Rah! Rah! comments are based on "look at all the bottom feeding going on!"

I really wish I were wrong.


On Jun 08 12:32 PM evergreen16 wrote:

> After reading few of these fear-and-gloom comments, one has to wonder
> - who are those kids writing these comments?
> Are they just bored high-school kids that just have fun firing back
> at peple without the ability to understand the subject at hand?<br/>It's
> funny how they think they are the smartest, untill they eventually
> grow up and realize they were dead-wrong.

Jun 08 01:47 PM

[dianeb:]

Shiller's article is yet another example of how people still don't get it when it comes to housing prices. To begin with, he doesn't address the fact that rational people would not hock themselves up to the eyeballs with toxic mortgages they clearly cannot afford in order to pay grossly inflated prices. At the peak, the median cost of a home was at least TEN TIMES the median household income; no sane, responsible lender would give a mortgage on that basis and no sane, responsible buyer would spend that much. When a bubble bursts and prices drop, it does not mean that prices now become "depressed;" rather, it is a CORRECTION back down to more realistic levels.

Housing prices will continue to fall for a long time for the same reason as they did in Japan; they rose to the point of being way beyond people's affordability and therefore became unsustainable. They will fall gradually not only because most people still buy their houses to live in and are not going to give up their homes if they can avoid it, but also because in any given year only a small percentage of people buy or sell their homes, so you still have a majority of homeowners who purchased their homes before the bubble at much lower, more affordable prices.

It doesn't take a genius to figure this out. The apparent stubborn clinging to self-delusion by rationalization and "analysis" of irrelevancies, and the lack of common sense displayed by even our supposed "best and brightest" leaves little doubt as to how we landed in this economic mess.

Jun 09 02:56 AM

[Jimmy K:]

Dianeb- i think you just nailed it. I've never seen it put so simply; so straightforward. Thanks.

"Housing prices will continue to fall for a long time for the same reason as they did in Japan; they rose to the point of being way beyond people's affordability and therefore became unsustainable. They will fall gradually not only because most people still buy their houses to live in and are not going to give up their homes if they can avoid it, but also because in any given year only a small percentage of people buy or sell their homes, so you still have a majority of homeowners who purchased their homes before the bubble at much lower, more affordable prices."

Jun 09 12:49 PM

[cynewulf:]

God has a plan.

Jun 09 11:54 PM