Housing Bubbles vs. Housing Cycles
June 29th, 2006 by KibitzerIn my recent post The Housing Bubble and Other Fine Myths a reader suggested their was a hole in my logic, and that recent housing price increases are not due to a population boom but rather low interest rates, exotic mortgages and speculation.
In this he is, of course, correct – but he misses the main point. It is important to distinguish between a housing bubble and normal housing cycles.
I actually went back over 40 years of housing and population data. While there are undoubtadly other factors to consider, the graphs make it clear that some relationship exists. For example: If you look at the early 1990’s (the period of the previous boom in housing prices) you’ll see a population spike in 1991-1993 along with a drop in housing starts and yes, a spike in housing prices.
But saying there is no housing bubble is not the same as saying there are no cycles in housing prices.
As I mentioned at the end of the article, there will be ups and downs. Personally, I do agree with Ian that recent prices have been driven by exceptionally low interest rates. I agree that speculation is a factor. The demand resulted in increased construction so housing is overbuilt. I expect that this will result, as it has many times in the past, in a decline in housing prices and a long period of stagnation (a decade would not be surprising). A drop in housing values of 20%-25% would be expected just based on normal housing cycles. Housing starts will slow, population will increase and the cycle will repeat.
Cycles are not the same thing as bubbles. A bubble is when prices become totally irrational and prices drop significantly. A bubble is what happened in Japan where real estate prices dropped significantly and will probably never go up again. The U.S. housing market is ultimately supported by increasing demand. In my mind that means it’s not a bubble.
I also wish to emphasize my original point that historical trends are not a guarantee of future performance (gosh, I’m beginning to sound like a mutual fund salesman!). Seriously, a fundemental change such as a population drop (bird flu, change in immigration policy), or structural change to the economy (depression, collapse in the dollar, elimination of the mortgage deduction, etc.) could change things significantly in either direction.
But based on what I know at this time, I certainly would not be speculating in real estate right now.
June 29th, 2006 at 7:09 pm
I agree with you for the most part, I agree that while prices are inflated, this is not a “bubble.” That is not to say that it can not “pop.” Today’s prices are fueled by demand, which means it is natural, however exotic mortgages have enticed speculators and people who probably are not as financially fit as they should be to become homeowners, flippers, or landlords. This year $300 Billion worth of Hybrid ARMs are scheduled to readjust for the first time, $1Trillion in 2007. A hell of a lot of people are going to get burned real bad, and those who can are going to dump their negatively amortized property like it was egghead.com; Of course, when the amateurs start selling is when the professionals start buying…
June 29th, 2006 at 10:04 pm
And the places where the speculation is the worst is probably going to be hit hardest. Get rich seminars notwithstanding, Real Estate is a risky game for those who aren’t careful and conservative in their investments.
The saving grace is that on a historic basis, long term interest rates are relatively low – so those who have managed to increase their income in the past few years may be able to afford to refinance to a long term fixed loan.
January 14th, 2007 at 10:48 pm
Other economists argue that recent price increases can be explained by limited supply and increased demand due to immigration and demographic forces.