Friday, March 25, 2005
Via Matthew Yglesias, the New York Times has an article comparing the current housing boom to the dot.com boom of the late 90's. I think they are right. It is the greater fools theory all over again. People are buying housing on the assumption that prices will keep rising even though the fundamentals don't support that (like the P/E ratios didn't support for the Dot.coms).

The population is aging, and developers continue to build more and more homes. Increasingly more of these homes are being purchased by investors who do not rent them out at all, but just hold them for a profit. Last year 25% of home purchases were by investors (that is just shocking - so shocking I have trouble believing it). But regardless of the percentage, this has the effect of artificially increasing apparent demand as people who actually are buying homes to live in still have to buy. Supply may very well have already vastly out paced demand, and we just do not know it because of all the investors.

At some point something will happen - increasing mortgage rates perhaps or a drop in real demand that reveals a glut in housing (more likely both in combination) - and prices will stop increasing or slow considerably as developers cannot sell their new homes. Then all hell breaks loose. Investors panic and try to dump their houses for any profit they can. Developers who have to sell given their huge financial commitment to the project, will have to match or beat those prices to get sales just to maintain the cash flow their operations require. Likely at the same time higher rates put additional downward pressure on demand, and prevent some who want to buy from buying. As investors see that they cannot sell their real estate holdings in a short time period (which are obviously much less liquid than stocks) they will lower prices more and more just to move them so they don't get completely wiped out.

It could get really ugly - in some markets (Florida and California) it could cause an out and out local recession/depression. I don't know if anyone really knows what kind of effects such a scenario could have on the general economy. But it won't be good.
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I am an attorney in Chicago. Politically speaking, I am an indepedent that tends to lean conservative on fiscal issues and progressive on social issues. I try to remain as unbiased and open-minded as possible. Please email or post any comments, and especially criticisms. If something I say is wrong, or you disagree - let me know about it!



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