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Predicting Housing Booms & Busts

September 19th, 2007 · 1 Comment

An article was published in July 2007 by Robert Shiller, author of “Irrational Exuberance” and creator of the Case-Shiller index, on the possibility of predicting housing booms and busts by studying their turning points in history reveals that it’s nearly impossible to predict a boom but busts are a bit more predictable. He also finds that going against the grain will help you out with investments in general because people tend to be herders. He focuses on the psychological and behavioral elements of the turning points to find reasons for their booms and busts.

He finds that real estate price historically have a smoothness to them because the housing market is made up of “ordinary folk” who do not react with the speed of professionals as you find in the stock market and that historically investors have been caught in booms because they do not understand the supply response to prices due to what he calls their “uniqueness bias”. The “uniqueness bias” is the investor’s overconfidence and ignorance of price because they fall in love with their investment.

The demand for housing is a stable component because most people only own one home and there can be only so much demand. He states that home buyers typically only take into account the interest rate to decide when to buy but they rarely take into account the rate of appreciation during that time.

Supply for housing is determined by the builders. When prices are much more than construction costs than builders create more supply and vice versa.

The interaction between supply and demand will determine the market price. The price component becomes volatile during the boom years because the increased demand caused by herding behavior. Simple Economics 101. He also concludes that the news media has a strong effect in facilitating this herding behavior.

He uses the events of the California Boom in the 1880’s, the Florida Boom in the 1920’s, the boom in the 1980’s, and our most recent housing boom to reveal some common elements in the turning point to the bust years from the boom years. He concludes that all these booms ended abruptly and had an element of surprise. Booms ended with numerous people filled with a sense of excitement turning into feelings of betrayal and embarrassment and the end of the boom nears when the underestimation of the supply is significant.

Here is the pdf of the Historic Turning Points in Real Estate by Robert Shiller article that reads like a college textbook but will provide a lot more background on the boom and bust years discussed in this text.

Tags: Market Forecast

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