During the housing bubble, prices detached from their fundamental valuations and became very inflated. This price inflation created a situation where affordability dropped to record low levels in many real estate markets. The fear of buyers was that failure to purchase a property would mean they would never be able to own because they would be priced out forever. For this fear to be realized, prices much sustain inflated levels of low affordability forever. Is this possible?
All market pricing is a function of supply and demand. One of the reasons many house price bubbles get started is due to a temporary shortage of housing units. This is a particular problem in California because the entitlement process is slow and cumbersome. Supply shortages can become acute, and prices can rise very quickly. This is part of the cycle in California. When prices begin recovering after a crash, supply is slow to the market, and prices begin to rise due to the shortgage.
In most areas of the country, when prices rise, new supply is quickly brought to the market to meet this demand, and price increases are blunted by the rebalancing of supply and demand. Since supply is slow to the market in California, these temporary shortages can create the conditions necessary to facilitate a price bubble.
Over the long term, rent, income and house prices must come into balance. If rents and house prices become very high relative to incomes, businesses find it difficult to expand because they cannot attract personnel to the area. In this circumstance, one of two things will happen: businesses will be forced to raise wages to attract new hires, or business will stagnate and rents and house prices will decline to match the prevailing wage levels.
California was particularly hard hit by the difficulty of business owners to attract qualified people to the state. House prices were so high relative to incomes that even with significant pay raises it still did not make sense for people to move to California from other parts of the country. A 30% increase in pay does not cover the cost of a 250% increase in someone’s housing cost.
In short, house prices cannot remain unaffordable forever, although it is certainly possible for them to remain unaffordable for long periods of time. During the housing bubble, prices in many markets were elevated beyond any reasonable fundamental measure. The inevitable crash brought prices back to affordable levels because buyers can only afford what they can afford.
Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall?
Learn more and get FREE eBooks at: http://www.thegreathousingbubble.com/
Read the author’s daily dispatches at The Irvine Housing Blog: http://www.irvinehousingblog.com/
[tags]housing, real estate, buying real estate, housing bubble, real estate bubble, house for sale[/tags]
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