After the real estate bubble in 2007-2008, prices fell pretty dramatically in some cities. While the prices are on the way up, some people think the market will “double dip”. Are they right?
I believe a few simple economic concepts are going to save us from another dangerous real estate bubble.
Let’s wrap our heads these concepts with some simple examples:
“Supply and Demand”
Why are diamonds so expensive? Because they’re rare and hard to find (unless you live next to Tiffany & Co.). Speaking of rare, in California, the price of water is getting more expensive because fresh water is in short supply. Basically, the less there is, the more expensive it gets. If you’ve ever tried to Uber at “closing time”, you know what I’m talking about! Usually you “manipulate” demand by increasing and decreasing the supply. In the real estate world, supply would be the number of houses on the market. Fewer houses means people pay more to get one.
However, back during the Housing Bubble, bankers were able to influence demand by making it EASIER to buy a home. (In fact, they made it too easy!) Because of the increased demand due to easy mortgage loans, construction companies continued to build more homes, and the demand kept increasing. Eventually, the whole thing crumbled when people realized they couldn’t afford their payments, nobody was buying homes anymore, demand went way down, and then, so did home prices.
“High Pressure and Low Pressure”
When you blow air into a balloon, it will rush right out unless you tie up the balloon. That’s because the air is compressed inside the balloon and it naturally wants to be less compressed. It’s the same thing with air in a car tire, a “super soaker” water gun, and so on. In Los Angeles, we have two major markets: The West Side and the East Side. I consider anything east of the L.A. River to be the East Side. Of the two, the West Side is definitely higher in pressure (higher prices).
That means, when buyers from the West Side see the lower prices on the East Side, they see tremendous value and are happy to pay asking price or way over. For example, someone living in Silver Lake might see Highland Park real estate prices and find a 2 bed, 1 bath, 800 sqft house for $700,000 a great value. However, someone living on the East Side might see that same exact house and think it was overpriced.
Naturally, the High Pressure begins to move downward into the Low Pressure area, and because of that, they raise the prices. And subsequently, the East Siders move further east across the city. Across the Arroyo Seco into East L.A, up into western Altadena, and further east into the San Gabriel Valley in places like Alhambra.
In my opinion, this High Pressure system is what sparked the Great Hipster Movement of Los Angeles.
“The Tipping Point”
Because of all this High Pressure spilling into the East Side, the prices have continued to increase, whereas on the West Side, they have significantly tapered off and increasing prices have slowed. Still increasing, but slower. However, right now the East Side is still an incredibly hot and expanding market—technically it’s imploding if we consider the West Siders moving into the area.
Right now, East Side buyers are at a disadvantage when competing with West Siders. I compare it to playing poker with a rookie. To a regular group of friends who play every week, losing to your friends has less to do about the $20 “buy in” than it does the fact that you lost to your friends. But, to a newcomer to the group, all they see is the $20. If they lose $20, big deal. So for that reason, they bet and bluff a little more frivolously than they should, and scare off the experienced players.
This is what’s called “beginner’s luck”. A buyer on the West Side is used to much higher prices than someone from the East Side, so the East Sider will likely be outbid for that reason. Here’s the problem: At some point, the value of lower prices on the East Side will become less attractive to West Siders, and they will stop buying.
This could be because they have to go further east which adds to their commute, or they don’t save enough money anymore to be worth it. When this happens, we will reach the Tipping Point where the West Siders are no longer interested in the East Side, and have semi-equilibrium.
“The Cost of Money”
Yes, everyone is talking about it: Interest rates are expected to go up soon. As a real estate agent, we are also expecting the real estate prices to taper off on the East Side just like they have on the West. My prediction is that the interest rates rising later this year will be that catalyst.
Let me explain: The lower the interest rate, the more Buying Power a buyer has. A lower interest rate means two things:
Lower monthly payments, or
The same monthly payment with a more expensive house.
Sellers and real estate agents are not intuitive, but the market is. When interest rates inevitably begin to increase, buyers (in general) will not be able to afford as much has as they could when rates were lower.
Two things will happen:
Buyers will seek lower-priced houses which will continue to fuel the Great Hipster Movement, and
Demand will decrease, houses will stay on the market for longer lowering demand even more, and prices will drop.
When this happens, we will see the “market correction” needed to taper off the real estate prices on the East Side and ensure that home values increase safely.
So, will there be another Real Estate Bubble?
If these economic theories hold up, the price increases should taper off back to normal appreciation. Higher interest rates will lower demand to buy a house and the number of people looking to buy will decrease.
This means the competition for buyers will slow down. This is good news for current homeowners and new buyers about to enter the market. I know homeowners want higher values, but we had a good ride, and they will still increase under this new paradigm, but more safely and responsibly.
What does this mean for Buyers?
Buyers should buy when they’re ready. Prices and rate go up, and they also go down. You can A) buy now and have a great interest rate which will save you money, or B) you can wait and potentially have an easier time finding and bidding on a house and maybe save money on the price.
In short, it’s always a great time to buy a house.
What does this mean for Sellers?
Obviously, it’s great to be a Seller right now. You have people fighting over your house and paying top dollar. But, once you do sell, you become a Buyer again and deal with the same problems as everyone else!
My advice for Sellers is a little different. Consider this: When monkeys swing on branches, they don’t let go of one branch until they have a firm grasp on the next one. Unless you plan on renting in between homes, a good idea is to get into escrow on your next house before you go into escrow to sell your existing house.