Why isn’t demand rising when prices are falling?

[powayseller]

A fellow piggington poster made an astute comment, in a debate we had on another thread about reversion to the mean. He said that prices would not necessarily revert to the baseline ratio of price/income = 7, because of demand.

His thinking was that as housing prices fall, demand will pick up and stop the freefall.

I responded by saying “Prices are down already, but demand, instead of picking up the last few months, keeps falling”.

Clearly, demand for buying homes is not about getting a good price. If it were, we would have seen far fewer buyers on the way up.

Demand for homes these past years has been on the *expectation of future large rises in prices*. People bought not because they needed a place to live, but because the thought the price would keep rising.

For that reason, even people who intended to live in their homes, bought a more expensive home, with a more exotic mortgage, than they would have, had the housing market been rising with inflation.

With buyer psychology turned from frenzy to almost gloom, they are afraid to buy now, not knowing how much further the housing prices can fall. So they wait…

But that is my take on it. What do other people think?

Why isn’t demand rising now that prices are falling?

[Bugs]

The simple answer is that demand is declining faster than prices are. The investors have basically withdrawn because there are no short term gains to be made. Bear in mind, this 25% of buyers largely drove the price increases, and their absence removes the support for the price distortion.

Anytime you remove 25% of the demand its going to take a while for the prices to equalize to the lower level of demand.

[BikeRider]

Makes me think of AMWAY and also LAMAS. I’m about to ramble, so hold on. I remember growing up in a small town. This guy had a cabinet shop, where he made wonderful hand crafted furniture and cabinets. Anyway, an AMWAY salesman came into the town and convinced this guy to start selling AMWAY. HE closed his shop and started doing it. He came to our house and tried to get my parents to sell AMWAY. From what I remember, AMWAY was sorta a pyramid scheme, where you keep getting people to sell AMWAY and that is your goal. As my comment of LAMAS, my wife got very facinated with lamas and wanted to go into the business. I went along, being supportive. Anyway, after a few years keeping lamas, I relized that the only people buying lamas were people that wanted to start a business selling lamas. I don’t think anyone that just wanted a single or pair of lamas, that WAS NOT going into business, ever bought one. We got out of the lama business. It was interesting and I guess a bit nutty thing to do. We didn’t make any money so to speak. Well, you look at housing the last few years. The majority of people buying and selling houses, are just that, the people looking to buy the house are looking to sell the house. They aren’t looking for a home. And they have driven the prices through the roof, making it very difficult for people that just want a home. I for one do not feel at all sorry for people losing money, if that person was being greedy. I’m all for making money, but hate it when people ruin something. Greed and speculation has ruined it for anyone that wants to fix up an old vintage 70’s muscle car. Do you know that some of the old muscle cars of the 70’s, like a Cuda, or Super-Bee, sell for $200K – 1 million dollars now? It is insane. So, if you have some vintage car like that and you’d like to just fix it up as a daily driver, just for fun, you could not afford to fix it if you were involved in an accident. Investors have ruined the hobby. Investors can ruin just about anything they touch.

[barnaby33]

You probably didn’t sell that many if you sold them as lamas, llamas however thats a whole other animal!

To link back to one of the professors analysis pieces interest rates have risen by 40% or so since last year. That means given the same financing schemes people can afford 40% less house. I actually don’t think demand has fallen 40% quite yet so as I see it, demand really is still outpacing rising interest rates though at this point just barely.

As many have said many times, it takes the market participants a while to digest these changes and to curb behaviour accordingly.

Josh

[sdduuuude]

“He said that prices would not necessarily revert to the baseline ratio of price/income = 7, because of demand.”

Well, not exactly. I said that analysis using reversion to the mean on the house price to income ratio is not as appropriate as analyzing supply and demand, but such as it is with paraphrasing.

Demand curves are tricky, especially in consumer markets because perception comes into play with demand curves.

Right now, perception is “Wait until prices fall.” So, if prices fall a little, the demand may not change much. If they fall a “medium” amount (whatever that means), people will take notice but may not act. Eventually, the “waiters” will buy.

Further, due to the median price measurement, people perceive prices to be nearly dead even over the last year, not down at all.

Lastly, there are real estate agents out there twisting perception. The demand side of things is a complicated mess right now. The mix of buyer types is quite varied.

It is undeniable, however that as prices go lower, houses are more affordable. And there are people waiting. That is the key to my comment. There are people and probably big investment dollars waiting …

[anxvariety]

My guess.. this won’t fit into your basic supply demand chart .. because 1. houses are more expensive than most things and 2. people look at housing as an investment and understand cycles

But if you want to try and figure it out maybe can start with:

Elasticity of demand and supply
The degree of buyers` responsiveness to price changes. Elasticity is measured as the percent change in quantity divided by the percent change in price. A large value (greater than 1) of elasticity indicates Sensitivity of Demand to price, e.g., luxury goods. Goods with a small value of elasticity (less than 1) have a demand that is insensitive to price, e.g., food.

[bob007]

the falling prices are neutralized by rising interest rates which means prices have to fall further

[powayseller]

Why aren’t those big investment dollars in the Nasdaq now? As the NASDAQ fell, why didn’t all those investors plunge back in, to scoop up those good deals? After Lucent fell from $90 to $7, why wasn’t it bought back up? Instead, demand kept falling until it went down to $2.50.

The statement that large price drops bring in investors is not what history has shown. Price drops create fear. Eventually, price drops revert to the mean, are backed by fundamentals, and investors come back in.

Housing is the same. Once it really falls, people will be fearful of further drops, so demand slows further.

My guess is that once rentals are cash flow positive, investors will come back in and start buying. This will create more activity in the low end, making the median KEEP dropping. Those who are only looking at the median, won’t even know the buyers are back in the market for one or two years, since the median appears to be 1-2 years behind.

I think the low end picks up first, and then ripples up to the mid and high end homes. So once rent = cost of ownership, the investors will come back in and turn this thing around. That will be when price/income = 7.

Those of us tracking the market closely will be the first to know when buyers are back in the market, and can buy our houses then. I am ready to wait 5-7 years.

[bob007]

lucent fell from 90 to 7 because their business was disappearing. The TDM networks were replaced by IP networks. Cisco was better at IP networks.

I can pay 300k for a SFR in mira mesa. it may or may not be overpriced. i would not mind. that would be a 50% fall from the peak.

[mydogsarelazy]

Here is my comment about demand…

Think binge/purge.

In the past four years every participant in the Real Estate market was transformed into a speculator. Everyone from flippers to first home buyers was gripped by a kind of speculative craze. It was like a national pyramid scheme.

Now there is a public perception that real estate is “over” and the purge begins. Money is going to move to other places.

What I find most interesting about what has happened can’t be found in numbers or charts. So much of happened was motivated by anxiety, greed,
and fear.

JS

[powayseller]

Bob007, I will estimate that in 5 years, someone will write

“Sd’s median home price fell from $502K to $300K because their buyers were disappearing. People were moving out, adjusting ARMs led to rising foreclosures, and jobs created during the housing bubble disappeared. Buyers became fearful of falling prices and disappeared. Many moved to cheaper areas, like Texas and Utah, where better deals were found.”

[Beach Rat]

Yep I hear you. A good friend of mine had a Super-Bee that was in pieces. I offered to help him restore it free of charge because getting that beast up and running would be a beautiful thing. He just couldn’t afford the parts for it at the time. Probably for the best, we may have killed ourselves in it even with just the 440 Six pack….

A drop in price should “Ideally” lead to increased demand. What this assumes is that the price drop is instantaneous and not dependant on time. If prices drop over time what is important is the rate of decline. What incentive is there to purchase something today that will be less expensive tomorrow be it milk, a car, or a house? The “New Price” for the asset will not be set until it reaches a new equilibrium where the 2nd derivative is zero, or the rate of decrease has effectively become zero. Then there may indeed be increased demand once the price has stabilized.

[Anonymous]

Why isn’t demand rising now that prices are falling?

Why indeed.

Why wasn’t demand falling as prices were rising?

I agree with ALL the answers so far. Elasticity, interest rates, trend perceptions, all help explain this. But you can only rationalize a largely *irrational* market so far. There will be buyers stepping into the market, even as prices fall and interest rates rise. Savvy sellers and their real estate agents will no doubt be there to close the sales. Home builders will be dropping their prices and adding incentives to move inventory. This is all pretty predictable.

What does the forum think about vacation homes? Will they be dropping as well? Faster or slower than primary residences?

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