On How Housing Bubbles Form and Pop

I found this old article over at iTulip. It makes some interesting points regarding the housing bubble. It discusses where housing bubbles tend to occur and what we can expect over the next few, short years. It just goes to show how insightful these folks are (they correctly identified the tech bubble burst early by the way).

1. Housing bubbles are concentrated in areas where buildable land is scarce, on waterfronts, and/or from where people commute to their jobs (e.g., Marin County):

How does it end? On the way up, housing bubbles grow differently than stock bubbles. They're regional, because folks buy homes near where they get their income, usually withing a 40 minute drive. Now I realize that in Northern California that could be two miles away on Rt. 101, but bear with me. That means prices fueled by too low interest rates will manifest where people and the jobs they drive, take a bus or train, or walk to are concentrated. Also, they happen in areas where land is scarce, such as waterfront property; speculation is encouraged by the reality of land limitations.

Popular belief today is that prices won't decline much in the future because land is limited relative to the number of people who want on it. Tell that the the Japanese who have seen real estate prices decline for more than 12 years. Too much land and not enough people in Japan? No. Even though interest rates have been near zero for years, the problem is that their incomes have been declining.

Low rates are the input of a housing bubble, areas of concentration of population or scarce land are where they happen, but low interest rates will not sustain the bubble forever. Just as housing bubbles are unlike stock bubbles on the way up, they're different on the way down, too.

2. Housing market bubbles don't "pop" according to the same time course as stock market bubbles. Instead, they gouge you piece by piece over an excruciatingly lengthy period of time. This makes them more insidious than stock market bubbles because there is so much more available time to talk yourself out of thinking that there is a bubble and that you might lose your shirt:

Unlike stock market bubbles, real estate bubbles don't pop. Collapsing stock market bubbles are characterized by a sudden collapse in prices because stock markets are highly liquid. You see huge volumes of transactions at ever lower prices during a stock market collapse. Collapsing housing bubbles, on the other hand, are characterized by illiquidity, a sudden collapse in transactions. Buyers and sellers seem to disappear.

The reason is a reversal in the psychology of buyers that developed at the top of a speculative housing market. Buyers had been buying at prices they knew were too high but on the assumption that they'd be able to sell if they needed to. The thought was: "Ok, maybe it's overpriced, but at least I'll be able to sell it later for at least what I paid for it, but likely more." What happens on the way down is that houses go on the market and just about no one shows up to look. That's because buyers weren't buying earlier primarily because they needed a place to live, but because they thought the price would likely rise [oh, do you mean like this?] and that, in any case, they'd be able to get out when they wanted with all of their money or more. On the way down, neither condition is true. So buyers stay home, so to speak.

Can't buyers be enticed by declining prices, by bargain hunting, you ask? No. Once housing sale transactions suddenly fall from, say, several hundred a month in a large community to, say, one or two a month, this creates fear and loathing about prices. Long periods of time pass when there are no transactions at all. Think of it this way. What's the comparable on your 3000 square foot home in San Mateo when the last sale was, say, seven months ago? Is it 10% less than the last sale of a similar home on the area? 30% less? This happened in Japan, and prices nationally are still more than 60% below peak prices in 1992, where real estate prices continued to climb for several years after their stock market bubble popped. Sound familiar?

Marin sellers who now find themselves on the down side of this speculative housing mania just have to remember one simple rule -- price sells.

And for Marin buyers -- don't catch the falling knife.