Widespread belief that home prices never fall
This folk wisdom is often heard, and appears to be encouraged by the real estate industry. However, it is manifestly untrue, as evidenced by the relatively recent price history of housing in locations such as New York, Los Angeles, Boston, Japan, Vancouver, Hong Kong, and myriad more.
Widespread belief that housing is a sound investment
For some this has been undoubtedly true, and for others, not. In fact, Robert Shiller shows that over long periods, inflation adjusted U.S. home prices increased 0.4% per year from 1890-2004, and 0.7% per year from 1940-2004. Shiller also showed comparable results for housing prices on a single street in Amsterdam (the site of the fabled tulip mania, and where the housing supply is notably limited) over a 350 year period. Such meager returns are dwarfed by investments in the stock and bond markets (but houses at least can be lived in, while stocks and bonds are only paper). If historic trends hold, it is reasonable to expect home prices to only slightly beat inflation over the long term. Furthermore, one way to assess the quality of any investment is to compute its price-to-earnings (P/E) ratio, which for houses can be defined as the price of the house divided by the potential annual rental income, minus expenses including maintenance and taxes on the rental income. For many locations, this computation yields a P/E ratio of about 30-40, which is considered high or very high for the stock market. Just before the dot-com crash, the P/E ratio of the S&P 500 was 45.
The "ownership society" versus renting
Though he did not specifically use it in this way, President George W. Bush's 2004 reelection campaign slogan "the ownership society" reflects the strong preference of Americans to own the homes they live in, as opposed to renting them.
Speculative purchases of homes
As median home prices began to rise dramatically in 2000-2001 following the fall in interest rates, speculative purchases of homes also increased. Fortune magazine's article on housing speculation in 2005 said,
"America was awash in a stark, raving frenzy that looked every bit as crazy as dot-com stocks."
In a 2006 interview in BusinessWeek magazine, Yale economist Robert Shiller said of the impact of speculators on long term valuations,
"I worry about a big fall because prices today are being supported by a speculative fever" ,
and NAR chief economist David Lereah said in 2005 that
"There's a speculative element in home buying now."
Speculation in some local markets has been greater than others, and any correction in valuations is expected to be strongly related to the percentage amount of speculative purchases. In the same BusinessWeek interview, Angelo Mozilo, CEO of mortgage lender Countrywide Financial, said
"in areas where you have had heavy speculation, you could have 30% [home price declines]. ... A year or a year and half from now, you will have seen a slow deterioration of home values and a substantial deterioration in those areas where there has been speculative excess."
The chief economist for the National Association of Home Builders, David Seiders, said that California, Las Vegas, Florida and the Washington, D.C., area "have the largest potential for a price slowdown" because the rising prices in those markets were fed by speculators who bought homes intending to "flip" or sell them for a quick profit.
