By Mike Heayn Real Estate 101
FOR YEARS, EASY FINANCING AND speculators drove the exuberant real estate market to unprecedented heights across the country. On August 31, 2007, Yale University economics professor Robert Shiller described the real estate market as having a “Boom Psychology.” A term such as “Boom Psychology” may be coined to explain the time when the greatest real estate market the United States has ever seen took place.
On Friday, August 31, 2007, Shiller submitted a paper to the Federal Reserve stating that “While it is possible that prices will continue to go up as is commonly expected, there is a high probability of steady and substantial real home price declines extending over years to come.” This is not to be taken lightly. With the liquidity markets thirsting for cash and lenders tightening lending standards it is important to keep the changing market conditions in mind before making a potential home purchase.
Shiller goes on to say that economic fundamentals cannot explain the 86 percent rise in real home prices between 1996 and 2006. The explanation Shiller gives is that of “Boom Psychology,” where buyers are anticipating home prices to be substantially higher in the future. This “Boom Psychology” was prevalent in Southern California, especially Los Angeles County. If you were looking for a home in Southern California between 2002 and the height of the real estate market in 2006, you understand what Shiller is talking about when he refers to “Boom Psychology.” Simon Sallom in an article he wrote a few weeks ago for the Santa Monica Daily Press, said one of his colleagues described the height of the real estate market as having “more time to think about buying a new pair of shoes than a million dollar house.” If you take a second to think about that statement, which summarizes the Southern California market perfectly, you will begin to understand “Boom Psychology.”
The report Shiller wrote also said that the United States has been undergoing “a classic speculative bubble, driven largely by extravagant expectations for future price increases... as such, the situation may well result in substantial declines in real home prices eventually.” Shiller’s concern is with the real estate market moving forward on a national level. He goes on to say that “major declines in real home prices — even 50 percent declines in some places — are entirely possible going forward from today or from the not too distant future.” That is a scary figure, much more so than the 86 percent increase in home prices, since a drop of 50 percent in home values would cause prices to dip below 1996 values. For example, if a property were worth $500,000 in 1996, an 86 percent or $430,000 increase would mean a value of $930,000 in 2006. If the value dropped 50 percent, it would be $465,000, or $35,000 lower than 1996 values.
Robert Shiller brings up excellent points, but what he refers to are home prices on a national level as an average. Since a real estate market is regional, not all markets will decline. Although it is possible for Los Angeles real estate to decline, it is unlikely — barring a massive disaster — that values will drop by 50 percent. It is more likely that values will level off with a decline in appreciation. Currently the Los Angeles real estate market still has a large appetite for home sales, so if you are buying a home for the long term, it is unlikely that home values will have a large impact on your life. However, if you are buying homes believing quick flips will lead to huge profits, you are mistaken.
MIKE HEAYN is a Washington Mutual Multi- Family Loan Consultant. He 310-428-1342, or emailed at
Originally published in the Santa Monica Daily Press print edition on September 12, 2007. Read the original PDF.