Housing and golf

I was playing golf with a client about 2 years ago, and as I was lining up a putt, I declared that it was impossible for the housing market to get so expensive that people couldn't afford houses. Home prices are governed by supply and demand like any other market, I reasoned. If the price is too high, demand would fall. Since demand (at the time) was in fact, rising, obviously prices aren't so high that homes were generally unaffordable. Obviously it could become unaffordable for a given consumer, but not for consumers generally.

What I ignored was the possibility of widespread investment in residential real estate. According to the National Association of Realtors, 27.7% of homes bought in 2005 were for investment. Investors have to outbid consumers for properties. It may be that a portion of homes bought by investors wouldn't have sold to a consumer, e.g., a home in such bad condition that its unlivable. In the majority of cases, though, investor demand has shifted the demand curve for homes outward.

So far, housing starts have fallen about 500,000 from their peak in January. Investor demand in 2005 represented about 2.3 million homes, so the lost demand from investors out-weighs the decrease in new supply.

As FRB of Dallas president Richard Fisher said the other day, the Fed really created this housing bubble by holding rates so low for so long. I am increasingly of the belief that investors speculating in the housing market really created the bubble.

Investors will not hold on to houses at a loss. They will either rent them out or sell them at a loss and walk away. The good news for the housing market is that if economic fundamentals continue to be strong, then it should only take 1-2 years to wring out the speculative investors. After that, I'd think the housing market will get back to a more normal pace of appreciation.