Paradise.If someone was invited to a dinner party and he arrived on crutches, the hosts would most probably take it as a slight and refuse to serve him. His plight would not be unique. Whenever we are ill we want to get better, not worse.
A similar sentiment applies to the housing market. In healthy times we see property as a way to enhance our lifestyle. But with the onset of the Covid-19 epidemic, we have seen an alarming rise in prices. And why is that? It is because of a fear of a second wave of infections that will keep our families and us at home for some time yet.
The urge to own real estate is not grounded in a very rational philosophy. It is a manifestation of our primitive wish to be independent and not be dependent on others. We still see housing as a way to store value for the future. Our living in a home seems like a guarantee for our future. Unfortunately this has proved to be a very dangerous delusion.
For a typical homeowner the problem of house prices is that the value of the house is not growing fast enough to match the fast growth of personal income.
Typically the more we earn the more we spend on housing. Income growth has outpaced housing growth. This happens even in healthy times. But now, when we are living under the shadow of an epidemic, income growth is decelerating. And that deceleration will not be short lived. We must therefore be careful not to fall victim to an irrational bubble.
In this article I would like to discuss some of the risks that are associated with rising housing prices. The first risk is that we will experience price overshooting. This is in line with a commonly held belief among market participants that real estate prices have moved too far. This belief is mostly driven by a rapid increase in house prices in the early 2010s.
At that time, we had a decade long housing boom. During that time, house prices rose by about 50 percent. And this was mainly driven by a sharp increase in supply. While supply generally tends to keep prices in check, in the case of housing there was a surplus of housing that kept prices well above their fundamental levels.
The 2008 financial crisis put a stop to the excess supply of housing. And as a result, house prices fell and have remained low ever since.
As long as there is excess supply in the housing market, prices will be higher than they would otherwise be. That is because excess supply does not add to the demand for housing. It simply leaves prices in line with their fundamental level of affordability.
But now we have an excess of demand. That is because the fear of a second wave of infections is keeping people at home. And those people who would normally be renting need housing. And with housing prices at record highs, that means they need to buy a house.