Housing: Speculation is the Key
I have taken to calling the housing market a "bubble". But how do I define a bubble?
A bubble requires both overvaluation based on fundamentals and speculation. It is natural to focus on an assets fundamental value, but the real key for detecting a bubble is speculation - the topic of this post. Speculation tends to chase appreciating assets, and then speculation begets more speculation, until finally, for some reason that will become obvious to all in hindsight, the "bubble" bursts.
Speculation is the key.
A recent report by the National Association of Realtors (NAR) reported that 23% of all homes nationwide were bought by investors. Another 13% of homes were purchased as second homes. In Miami, it was reported that 85% of "all condominium sales in the downtown Miami market are accounted for by investors and speculators". This is clear evidence of speculation.
There is a fundamental problem, however, with this analysis. While it is true that speculation does serve to distort the underlying fundamentals, driving up prices by investors restricting the supply of the underlying good, the underlying motivation that has caused housing prices to appreciate is a real housing shortage.
From the Los Angeles Times: Home Builders Looking Inward
As Southern California's sprawling suburbs hit their outer limits, home builders are increasingly turning inward to the urban core and squeezing development into once-overlooked morsels of land oil fields, aging strip malls, industrial complexes and parking lots in heavily developed areas.
And although moving outward remains the dominant trend, more families such as the Hernandezes are choosing a city life with all its challenges over longer commutes from the suburbs.
Of course the Los Angeles times thinks that higher density population centers is only a good thing:
The revival is part of a trend that is breathing new life into urban communities nationwide, such as in former steel mill neighborhoods in Pittsburgh, Baltimore's waterfront and old industrial areas around the Chicago Loop. The lofts and apartments proliferating in downtown Los Angeles are turning the area into something it hasn't been for decades: a residential neighborhood.
Yet one quote from the family the Los Angeles times uses at the top of it's article is telling:
Instead, they're on a waiting list for a home closer to their jobs a three-bedroom Inglewood home that will be on top of an old oil field, next to the Hollywood Park racetrack and under the flight path for LAX.
"You'd be amazed what you can get used to," Polly Hernandez said.
The two most important things a local municipality can engage in is infrastructure development and land use issues. These two things go hand in hand: municipalities have the right to dictate land use in order to control infrastructure development.
However, like all things, it is vital that municipalities use a "light touch"; otherwise, we are left with a situation of near double-think, where the individuals are frustrated and not getting what they want, such as poor Poly Hernandez who will have to live with exceedingly loud jets flying over her head until one o'clock in the morning flying in to one of the busiest airports on the west coast just so she can have four walls and a roof not shared by a common neighbor. Yet from the outside urban communities have had "new life" breathed into them.
Urban communities which are nice to visit--but you certainly wouldn't want to live there.
So why is in-fill development and living on old oil fields or under the flight path of jumbo jets preferable to moving ever further out? Because of ever longer commute times--made worse by a number of municipalities which have concentrated on mass transit designed to "shape" communities rather than transportation corridors which address the real needs of the people who live there.
It is unfortunate that many municipalities have taken the responsibility of their civic trust as a license to engage in social engineering. The billions spent in Los Angeles to build a subway system (you knew LA had a subway, didn't you?) could have been spent significantly improving the transportation corridors along Sepulveda Pass, through Downtown Los Angeles, and along the 10--and now the 118 freeways. But instead we got a subway system with stops dictated as much by politics and the desire for social engineering than by actual need, with a carrying capacity which is only a small fraction of the number of people who pass through any one of a dozen different freeway exchanges.
The Angry Bear essay at the top speculates that the Housing Market will not "pop" but deflate slowly as historically home sellers willingly support "artificially high" housing prices by removing supply from the market--by refusing to sell their homes if the prices are too low:
Housing "bubbles" typically do not "pop", rather prices deflate slowly in real terms, over several years. Historically real estate prices display strong persistence and are sticky downward. Sellers tend to want a price close to recent sales in their neighborhood, and buyers, sensing prices are declining, will wait for even lower prices.
This means real estate markets do not clear immediately, and what we usually observe is a drop in transaction volumes.
However, while there may be a relative short-term real-value deflation in the market, as happened to my home a few years back, until municipalities stop engaging in social engineering and start addressing the desires of their citizenry, long term housing prices will continue to go up.
And we will continue have more and more urban mixed-use neighborhoods which are fun to visit--but you sure as hell wouldn't want to live there.