House-Price Momentum: The Good News

John Authers looks at what drives house prices:

Tim Bond of Barclays Capital points out that once house prices start to accelerate, people expect them to keep on rising at that rate. All other factors are swamped. As he says: "After a period of strongly rising prices, the expectational component comes to the fore and becomes the key factor determining real house prices."
If people see house prices rising, greed trumps everything else. In the short-term, this is a self-fulfilling prophecy.

The interesting thing is that this mechanism does not work in reverse. The unique thing about bull markets in housing is that fear and greed both mitigate in favor of higher prices. The greedy want to make money, like they always do. But the other huge factor is the fearful - people who are watching prices rise inexorably and who feel that if they don't buy now, at any price, they'll never be able to afford something.

In a bear market, by contrast, fear of falling prices is a very small factor in house-price depreciation. Once someone owns a house, it's very uncommon for that person to sell just because they think prices are going to fall. Meanwhile, there are still speculative buyers out there - people who think they can use the current weakness in the markets to pick up bargains, often out of foreclosure.

Which is why there's every reason why house prices rise in a bull market, and fewer reasons why house prices fall in a bear market: foreclosures and oversupply are the main technical reasons for price drops. In turn, that might help explain why Manhattan seems to be immune from the housing bust (for the time being): neither is a factor here.

Comments

[Fin:]

The increase in housing inventory and foreclosures has already brought prices lower and this trend is expected to continue for quite some time (perhaps 18 months or more). Additionally interest rates are expected to increase during this time period. In terms of the emotions of greed, fear, and humiliation, most people would rather sell and either downsize or rent rather than go through the humiliation of foreclosure. I think it will take quite some time before inventory starts moving agian and it will be at substantially lower prices versus today.

2008 Feb 24 10:24 AM

[number2son:]

Your thesis falls apart if you stop to consider affordability is still too low and prices must continue to adjust downward. Lending standards are returning to the mean, which means no more no-doc, 0% down loans. People will actually need to put equity at stake in their home purchase (imagine that!) and prove that they can make the monthly payment.

2008 Feb 24 10:34 AM

["Magazine-C...:]

Regarding on-the-way-down -- sure, if an owner can afford to pay the mortage and doesn't expect prices to continue to fall.....

And don't have a situation where they are much better off walking away.

2008 Feb 24 03:27 PM

[Jack K:]

People said the same thing in 1989. Prices went up fast in the mid 80's but won't really come down. They did! Some more than others. Especially condos which were overbuilt. This time it may be residential homes that were overbuilt. When supply exceeds demand, prices fall. They do go down slower than they go up. And probably not as much.

2008 Feb 24 05:15 PM

[Carl leason:]

No question that prices went up at a really fast clp in the 2001-2006 era but the real area of falling prices now is in condos which have a vast over supply. That's where the investors went nuts. The one thing that most people over look is the fact that the housing market is way over in supply some in areas, like Florida, and other places where people bought those smaller homes as "speculators",..thinki... they will just buy something and place it right back on the market. Well, surprise, surprise,...they are not going up anymore ! I just completed a study in the Clearwater, Fl area and found that at the present rate of sales, we have a 2 year supply, even though prices are coming down, taxes and the monthly maintenance went up along with those higher prices and now taxes and ins. are stuck at those higher rates,..and the politians got used to the higher income and trying to bring down taxes is like tearing down the pyramids,.they simply are not coming down. ! So get used to the fact that it will take some time for this particular market to recover. There are many areas where this phenom. is happening,..like NC, TN, KY, even Wis...but it's spotty. We are even seeing this in Austin , TX where everyone thinks it's so great, and it may be,..for some, but as compared to national averages, the place is way over priced. Bottom line, if you don't look at National ave. prices when buying a home, you may get stuck, big time ! Fl again, is now priced at 6 pct. above the national average. So that tells me that it will take 18 to 24 months, at a min. for this market to recover. Interesting point also is that in some developments, there are some condos priced way below average, because the owners bit off more than they can swallow and so there are some bargains out there, but right now, and primarily because of the state of the economy in general, (Nationally), with huge debt, huge problem with balance of trade, higher food and gas prices, people are holding their breath that they can keep their jobs ! Everything considered, , I think that a recovery is going to take longer than most people can cope with,..as proof, our FL newspapers are full of ads. for Auctions with no reserve, on some nice homes. I don't think anyone really knows how bad it's really going to get before a true recovery starts. LC

2008 Feb 24 09:30 PM

[Living Off ...:]

That's a faulty thesis.

Just because prices are sticky at the higher end doesn't make them immune from falling. when the financial institutions start laying off people, you should see a drop in prices.

Even Jim Rogers sold his manhattan pad. He doesn't need the money, its just overpriced and as a value investor, he doesn't see the value.

I heard similar arguments about San Diego Prices 2 years ago. Its a lifestyle city, people will always move there, best climate in the US, job diversity, etc. But prices have still fallen 25-30%.

Real estate trends are long and difficult to change.

2008 Feb 25 12:17 AM

[Mr Pasadena:]

I completely agree with Number2son. This article would be correct in a normal market. But remembering that the only real reason people can afford these home prices was because banks and investors were giving money away for mortgages. That isn't happening anymore. Most lenders now want people to have a vested interest with a down payment. Let's see how many average income people can produce that who don't already own a house. I can afford to buy a second house but don't see it as an investment and neither does many of my other friends. Why would I pay additional property tax with a larger mortgage payment? I still need a bigger house but not at these prices. An now I can just wait or just add to my current house.

2008 Feb 25 09:21 AM

[Jack B:]

I believe what you're saying is true to a degree. However, we're reaching a point where housing costs represent too large a component of disposable income and the baby boom generation is starting to run it's course which means more downsizing for homeowners and a larger inventory glut. Domestic bargain hunting only makes sense when property values are going to be on an upswing within a reasonable time frame. Foreign investment in our assets will depend on individual economies. Europe is poised to slow down, China has exposure to a slowdown in exports to key regions and a looming health crisis due to pollution, the Middle East will be affected by a gradual transition to alternative energy sources, competion and slowing demand. These factors alone should put a drag on things.

2008 Feb 25 11:17 PM

[DC Housing ...:]

This is another situation where housing bulls are grasping at straws. I've commented about this before, if you look closely at the arguments made by housing bulls, they always try their best to avoid talking about the fundamentals. The problem is, and we've seen this time and time again, while the US economy is pretty efficient, you can still have bubbles in the short term. In the long run though, you always have to revert back to the fundamentals, it's just a matter of time.

There are several very powerful mechanisms that are going to cause home prices nationally, and in bubble markets in particular, to continue to fall:

1. Debt service ratios for home ownership must revert to historic levels. Homeowners simply can't continue to spend upwards of 40-50% of their gross income on their mortgage, this is particularly true in California.

2. Mortgage rates will continue to rise. Long-term mortgage rates are still historically low, sooner or later, these need to adjust upward to reflect a more realistic risk premium and increased inflation expectations.

3. The cost differential between renting v. owning must come closer to parity. Certainly there should be an ownership premium, but in most markets, again, California is a prime example, the monthly outlay per month can be 2-3 times the rent for a comparable property. As consumers get squeezed through higher commodity prices and record debt levels, renting is suddenly looking much better than owning.

So the bottom line is this: home prices will continue to decline until these ratios are normalized, PERIOD. In some markets this will be quicker, in others, we're going to see a housing depression like we've never seen. Anything else people say until then is just noise.

2008 Feb 26 04:21 PM

[LAX user:]

I agree with the bad thesis viewpoint. Removing speculators from the demand side of the equation, continued build-up in supply with no bottom in sight will rapidly increase depreciation as buyers sit and wait for signs that appreciation is on the horizon. People will wait to buy and may buy in dribs and drabs but oversupply will outpace, lack of affordability and no g'tee of appreciation means most will consider whether they can actually afford monthly payments without giving thought to refi-ing out of higher payments. The answer in places like Los Angeles, FL, and eventually NYC will be that without wage increases catching up people cannot afford payments at this level. ....And mtg co's are not lending as freely and verifying incomes affecting demand.

2008 Feb 26 06:32 PM