In 2007 housing prices did something that was unthinkable at the time. They started to go down. And by the end of 2008 the Case-Shiller home price index reported its largest price drop in its history, a contraction of 18%.
Homeowners found this drop in the real estate market so shocking because in their recent memory, property values had only gone up. In fact, this belief in ever-appreciating real estate may have worsened the crisis as many people had taken on debt with the assumption they could always pay it off with the growing equity in their house.
In the past few years a “hot” real estate market, with home values increasing at 6% a year, has turned super-hot with year-over-year increases of as much as 25% in some cities.
Observable history and basic economics indicate that price increases almost certainly cannot continue at this pace. In order to sell a house for one-fourth more than it was worth last year, you have to have a buyer not only willing but able to pay that premium.
As values continue to soar, more and more buyers are being priced out of the market. Naturally, the question on many people’s mind is, “Will the housing market crash in the near future?”
Dire predictions always seem to grab headlines. But even those who claim to foresee a major real estate correction admit that it probably won’t look like the crash of 2007-2008. For one thing, the economic factors are different.
In the run-up of the early 2000s a combination of easy mortgage qualification requirements and the popularity of adjustable interest rate loans led to waves of homeowners defaulting on their house payments.
This time around those two factors are not present.
Robert Shiller, Nobel Prize winning economist and co-creator of the leading housing price benchmark, says that the current market has some aspects of a bubble to it, especially the way people are making sense of it as a “story.”
Shiller observes that similar to the early 2000s, “There is excitement and people are talking and some people are bidding way more than the asking price and that becomes a narrative or a story.”
People tend to be driven by narratives and sentiment. And when that overarching story changes, so does economic behavior. The new story, in this case, would be that real estate cannot be expected to go up by double-digits every year.
Shiller is predicting that prices will eventually drop, not overnight, but, as he says, “enough to cause some pain.”
Predicting the future of any market is almost impossible. Who could have guessed that last year’s overpriced homes would look like bargains in today’s market?
Knowing that the future value of any asset or investment is uncertain, the most prudent course of action for an investor saving for retirement is to be broadly diversified, focused on the long-term, with our support.