DesperateBuyer, you are most likely wrong, but I do appreciate dissenting opinions so I’ll take the time to elaborate on why exactly you’re wrong.
First of all, a definitional issue. What is a “bubble” where asset prices are concerned? Here I defer to Jeremy Grantham (of Grantham Mayo Van Otterloo), one of the few true giants of finance from the last quarter century: “While Alan Greenspan may have a difficult time identifying an asset bubble, I do not – it is any market in which prices deviate by more than two standard deviations from their long-term trend.”
In a newsletter a couple of years back, Grantham explained that his team of quants had identified 28 bubbles (using his criteria) in asset markets over the previous 70 years. Of those 28, 27 had eventually reverted to their long-term trend line. The only one that didn’t was the S&P’s bubble of the late-90s, although it did decline to within 10% of its long-term trend (in contrast, the Nasdaq bubble did decline to its long-term trend before reversing). Anyhow, Grantham believes that much of the US property market (mainly the big cities on the coasts) is another bubble because, simply, it too has moved to (well) beyond two standard deviations from its mean long-term trend vis-a-vis virtually every metric available for analysis: price-to-rent, price-to-income, price-to-debt service, etc. – you get the picture.
Now, it’s always possible that the “fundamentals” (rents, incomes, etc.) will catch up with prices such that prices merely stall for several years. Interestingly, however, in Grantham’s research he found that in 27 of 28 bubbles, prices ultimately reverted to BELOW the trend line before resuming their upward march. Where SD housing is concerned, that would mean a decline of about 35%-40% from here on a median price/sq.ft. basis (we’re down about 6%-7% or so from the peak as I write).
Now, I don’t know whether the bottom is going to be another 20% down from here or another 35%, but I’m pretty sure of one thing: The decline is gonna be a whopper – and enough of a whopper that anyone with a functioning brain will in hindsight say, “Shit, that was one hell of a bubble that just blew up in our faces.”
One thing that a lot of people lose sight of is that everything important in economics (of which finance is a branch) happens “at the margin.” Which is to say that the most important pricing issues occur with the marginal buyers and sellers, and they do not have to be large in number to have an enormous impact on pricing. For example, the rate of home ownership was 66% in 2000 (after bouncing around between 59% and 66% since WWII) and climbed to 70% in 2005. When the history books are written I think we’ll find that that extra 4% – the marginal buyers – were only able to buy as a result of easy money financing. Once this financing dried up – as it is right now – the marginal buyers turned into marginal sellers and all hell broke loose at the all-important margin. Add in the speculators to this mix and you’ve got a toxic situation brewing at the margin.
Equally important: humans are, well, human. They’re emotional and do stupid things. As prices were increasing over the last few years, otherwise rational people bought property not because of fundamentals but because of the observation that prices were increasing. In other words, price increases – as opposed to similar increases in incomes, rents, etc. – drove people to speculate in properties. Price increases begat price increases. This is how bubbles work. (I should know – I wrote about the Nasdaq bubble in 2000 while working on Wall Street.) Bubbles are social phenomena because people are social animals. The bursting will be the upside in reverse: people will sell because they see prices declining (others selling). But, again, whether we get back to trend quickly or over a period of many years is anyone’s guess… I ain’t that smart.
Having said that, when you write that it “is simply absurd and ignorant to call this a speculative bubble” you reveal a great deal more about yourself than the real estate market about which you proclaim to know so much.
Now, having said all that begs the question… how do YOU define a bubble? And what, specifically, about the SD property market leads you to believe that we’re not in a bubble? (Note: Please use specific numbers, ratios, etc. – data speaks to me.)
