To my amazement, no less than my former analytical nemesis—the San Diego Union-Tribune—recently published a perfectly cordial article about this very website. That the UT has gone from exclusively rehashing CAR propaganda to interviewing some bearish-on-real-estate jackass with a sporadically Victorian-themed website just goes to show how much sentiment has shifted in the past year. But while interesting, the sea change in local sentiment is not what this article is about.
Instead, I want to expound a bit on the section of the article that generated the most feedback:
He does a lot of substantive research, and he kind of caught on because he was one of the guys who didn’t have the go-go attitude of the Association of Realtors,” [local real estate consultant Gary] London said.
But statistics alone don’t tell the story of why people buy homes, London contends.
“Rich understands the numbers, but he doesn’t understand the role psychology plays in housing,” London said. “That’s where guys like Rich miss it.”
I know Gary, and I think he’s a real good guy who is making an honest effort to figure this stuff out. But we disagree on some things, and as would be expected I disagree specifically with the characterization that I don’t understand market psychology. Given that I’ve been accused of this before, and will probably be again, I thought I’d take some time to set the record straight. Besides, what’s the point of having my own website if I can’t occasionally use it to get in the last word?
I suppose that one could note my emphasis on data and assume I am some sort of impassive misanthrope whose only glimmer of pleasure comes from long nights spent manipulating my beloved database tables as my long-suffering wife looks resignedly on in aching loneliness. Our hypothetical reader believes that such a person—perhaps our reader now pauses to wonder whether such a joyless automaton can even be considered a person at all—could never understand the role that psychology and emotion play in buying a home.
Well, it’s a nice idea, but the reality is that I understand the psychological forces at work perfectly well. It is the still large but ever-dwindling herd of real estate permabulls who does not.
There is but one purpose served by all those fun-filled charts and graphs in the Bubble Primer (the series of articles, accessible at the upper right of this page, in which I lay out my case that San Diego housing is both way overpriced and at risk for a steep correction). That purpose is to use the process of elimination to zero in on the causes of the home price runup. One by one, we look at the actual numbers and see that none of the usual suspects—population, housing stock, income, rates, nice weather—can explain the magnitude of San Diego’s recent home price growth. And when you rule out all those potential demographic and economic causes, only one thing remains: psychology.
The psychology, to be specific, of a speculative financial mania.
The typical San Diegan has been trained by a long and stunning rise in home prices to believe many things. He believes with all his heart that owning real estate is the road to riches. He believes continued rising prices will soon render him unable to buy a home, and that he should thus buy one now at whatever the price. Since he believes that real estate never goes down, he has no issue borrowing the full cost of the house through an adjustable rate, negative amortization loan. Sure, the payments will go up in a couple years, but he believes that by that time he will have sold his new home at a tidy profit and moved up a rung on the ladder to real estate barony.
These are not rational beliefs that are borne out by facts and figures. They are beliefs of the heart—a gospel that is sung by an entire city of happy and equity-rich homeowners. Why bother checking the facts on something that is common knowledge? Why question all those Lexus-driving real estate investors whose recent financial success must indicate some superior understanding of the situation? Perhaps most importantly, why allow your smug co-worker or neighbor to make all the money and leave you behind? It’s much easier—and apparently more profitable—to starve your fear, feed your greed, and follow the crowd.
My friends, it is all psychology. That’s what this market is all about. Emotions are the rocket fuel with which San Diego home prices have been launched into the stratosphere. It is the people who deny this fact—making specious claims of a housing shortage, a vast increase in incomes, or a population surge—who do not understand the role that psychology has played in San Diego’s housing market.
What will happen when that optimism wanes or, worse yet, is replaced by pessimism? That’s the question everyone should be focused on.
I am fully aware that houses aren’t like stocks. People will not just dump their homes overnight if the market starts to sour, but will rather attempt to hang onto their homes until the market turns up again. As I outlined in the second Bubble Primer article, however, there are many reasons to believe that a large proportion of recent homebuyers have bet the farm on continued home price increases. The issue is not whether these people will choose to keep their homes when the emotional rocket fuel runs out and the artificially high demand for housing disappears. The issue is whether they will be able to keep their homes. To the extent that they are not able to do so, distressed selling will only render the market (and thus the market psychology) worse, which will in turn put more homeowners into financial trouble. Such a negative spiral could shift the entire emotional gravy train into reverse.
Of course, one can’t know exactly how the San Diego real estate market will play itself out. One can only interpret new developments as they occur, and in order to do so it is crucial to view market psychology from within the proper analytical framework. Those who deny that the San Diego housing market is in the grips of an emotion-fueled speculative mania are doomed to misinterpret the situation every step of the way.