Tuesday, March 07, 2006

Supply and Demand

Pricing is determined by Supply and Demand. Period.

You can say the last bust was fueled by the areospace industry collapse or recession - it really doesn't matter because those things are simply factors that affect supply and demand. You can say exhuberance (irrational anyone?) fuels the increases, but that is simply a factor that affects demand.

And when you look at the RE market purely in terms of supply and demand, and the figures we're seeing right now, there is no conclusion except that a housing bust is upon us. But the market is not liquid enough to undergo sharp changes like the stock market where a single report can drop a stock price like a rock. In analyzing past booms and busts, the RE market is like a rollercoaster, at then end of a large boom (and this is the largest) it slows at the peak and crests. Downward momentum begins slowly and builds exponentially, the force of the movement feeding on itself.

During the years 2001 thru, and especially including, '03-'04, the RE market was in a frenzy. Many listings were sold in days. Not weeks, days - with multiple bids. There was not enough supply for the demand and bidding wars were common. Accordingly during this period of exhuberance, home prices increased monthly. Demand was incredibly high. And because of the strong appreciation, not many people that didn't have to sell were particularly inclined to. Why would you, when holding the property was making you more than your salary over a year? So the supply was very restricted. It's a little weird how these market forces feed upon themselves. But there is a limit. Demand is ultimately curtailed by affordability. If you can't qualify for a loan, you no longer contribute to demand. And demand begins to decrease. How does this end? Badly for some, depending on your timing.

Right now, supply vs demand has turned upside down is getting worse (better if you're a buyer). Supply is going thru the roof as speculators run for the exits. On top of that, demand is decreasing. Prices are dropping due to this pressure in "leading areas" where appreciation came late and strong and builders overbuilt to meet the inflated demand. In other places price appreciation has flattened while listings have doubled or tripled and sales decline steadily. In those places, the sellers may think they're in a staredown that they can win thru patience, but this Mexican Standoff favors the buyer. The buyer can continue to rent indefinitely with no change in lifestyle, while the seller is carrying an extra mortgage payment every month. My $1000 vs his $5000. No contest. Once prices start to slide he loses equity on top of the 5K. That will add "corrective" pressure. ...and the rollercoaster gains speed.


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