When prices rise faster than their wages, people can obtain less real estate with their income. The natural fear under these circumstances is to buy whatever is available before there is nothing desirable available in a particular price range. This fear of being priced out causes even more buying which drives prices higher. It becomes a self-fulfilling prophecy.
Of course, the National Association of Realtors, the agents of sellers, is keen to exploit this fear to increase transaction volume and increase their own incomes. If empirical evidence of the recent past is confirming the idea that real estate only goes up, the fear of being priced out forever provides added impetus and urgency to the motivation to buy.
Just before the stock market crash signaling the beginning of the Great Depression, Irving Fisher, a noted economist at the time, was quoted as saying “Stock prices have reached what looks like a permanently high plateau.” Of course, stock prices dropped significantly after he made this statement. This sentiment is based on the idea that inflated prices can stay inflated indefinitely. However, when valuations cannot be pushed up any higher, prices cannot rise at a fast rate.
In residential real estate markets, the rate of price increase would only match inflation because wages and inflation are closely correlated. If the rate of price increase does not exceed ordinary investments, people lose their enthusiasm for residential real estate as an investment, and they begin to look for alternatives: people choose to rent rather than own. Also, when the quality of units available for rent at a given monthly payment far exceeds the quality of those available for sale at the same monthly payment level, people choose not to bid on the property and they rent instead.
One sign of a housing bubble is a wide disparity between the quality of rentals and the quality of for-sale houses at a given price point. People choosing to rent curtails the rapid rise in prices and thereby lowers the demand for real estate. This puts downward pressure on prices, which eliminates the primary motivation speculators had for purchasing the asset.
Greed created the condition of rapidly rising prices which in turn spawns the fear of being priced out. When greed ceases to motivate buyers, prices fall.
Once prices begin to fall, the fear of being priced “out” forever changes to a fear of being priced “in” forever. A buyer who overpaid and over-borrowed will be in a circumstance where they owe more on their mortgage than the property is worth on the open market. They cannot sell because they cannot pay off the mortgage. They become trapped in their homes until prices increase enough to allow a breakeven sale. This puts the conditions in place to reverse the cycle and causes prices to drop precipitously.
The Great Housing Bubble saw many people react in fear and believe they needed to buy now or be priced out forever. Little did they know that buying because of fear would cause them to be trapped in their homes awaiting foreclosure.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author’s daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
[tags]housing, real estate, buying real estate, housing bubble, real estate bubble, house for sale[/tags]
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