It’s Economics 101!
Chuck Ponzi December 15th, 2005
A great little piece came out in the San Diego Union Tribune today with a few notable quotes that are a bit amusing. Here are a few of notable quotes:
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Despite rising interest rates, a growing for-sale inventory and a slowing sales pace, the county’s shortage of housing will prevent prices from dropping steeply, speakers asserted.
“It’s Economics 101,” said Leslie Appleton-Young, chief economist for the California Association of Realtors. “It’s demand and supply.”
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and …
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The fundamentals of the housing economy remain sound, said Louis A. Galuppo, director of USD’s Burnham-Moores Center for Real Estate. “We may see a decline in sales but not prices.”
Despite “air leaking out of the tire,” there are no major economic triggers, such as massive job losses, to cause the housing market to crash, said Joe Anfuso, chief financial officer of Shea Homes San Diego.
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I agree, it most definitely is Economics 101.
Anyone who has ever taken an economics course should be familiar with this picture:
It’s the demand curve and the supply curve. Basics: People buy more of something when it is cheaper (downward sloping demand curve) and suppliers supply more of something when it is more expensive (upward sloping supply curve). The market price is where the demand curve intersects with the supply curve. We won’t talk about elasticity of pricing or supply lags or anything, just the basics.
We all know that long transaction settlement times will make it an illiquid market and imperfect information make the market inefficient, so for the moment we will assume that we are currently at the perfect market price.
So, if quantity goes down, what could that mean? Well, back to Econ 101, it must be 1 of 2 things:
1. Shift in the Supply Curve
2. Shift in the Demand Curve
Without an exogenous shock, economists normally dismiss #1 and go right to #2. However, for the sake of fairness, we’ll consider it.
Shifts in the supply curve to supply a lower quantity would generally mean a higher price. Suppliers would do this if prices of raw materials increased, restrictions were placed on output, or some other event would cause them to be unable to provide more quantity. However, all other news articles recently have pointed to a consumer-led slowdown, and no immediate event has happened to suppliers to slow production in recent months. (Please, any reader correct me if I am wrong)
So… what does a shift in the demand curve mean? Well, that would mean that consumers are unable or unwilling to pay the prices, and have scaled back on purchases. (Once again, intentionally simplified) This would result in a left-shift of the demand curve.
Now, illiquid markets with imperfect information tend to overreact to information and overshoot the fair price of the goods.
So, how is that supported by Mr. Galuppo’s assertion that we can decrease transactions without decreasing prices? Well, anyway, it’s not Econ 101.
Which leads us to his second assertion; there are no major economic triggers such as massive job losses… Well if that isn’t just a jinx on the whole thing.
Besides, with the economy so dependent on Real Estate transactions and values, well, shoot, we’ll dang near just squeak by without all of that additional transaction volume, right?
Despite rising interest rates, a growing for-sale inventory and a slowing sales pace, the county’s shortage of housing will prevent prices from dropping steeply, speakers asserted.
If that isn’t classic denial then I don’t know what is. It doesn’t matter how illogical a statement is, people will reduce it down to the final conclusion of ‘prices won’t drop’ and that will be their ‘take home’ message.
“will baby boomers be buying your home from you? Not likely. Their tastes, needs, and wants are all different from other age groups.”
This is so true! Now, to add fuel to the old fire of hating baby boomers lifestyle ( a discussion I picked up from another blog) how do you see this:
A couple I know bought a small house/townhome in OC (CA) WAAAAAAY, smaller than their old house in Culver City. They made a small profit in the change about six/seven years ago. This happened when he retired. Now she has retired, and what do they do? Although they have no savings except for her annuity, they decide to put ALL her annuity money in a tiny appartment in ski town in Southern FRANCE!!!OooooH LA LA! It costs them about 5,000.00 just to get there, since it’s nine hours away from Paris so you need to take another plane, and the place is not even an appartment, more like a bunker to change clothes between ski outings. Tres Chic!
What do you make of that?
How much do you blame Greenspan for the insane Credit expansion that’s occurred over the last 18 years?
I’ll actually tell you have you can decrease transations without decreasing prices: its called “no good inventory.” So, while the NUMBER of sales fall, there are still “more” seekers of “good/fairly/market priced houses than there are “good houses.” So, despite the lower overall volume, “demand” still outstrips “supply.” How could this be, you ask? Well, people stay in their current house thinking “I can’t BUY UP in this market, even with the huge profit on my house” or people “wait to put their house on the market anticipating a dip and a chance to buy up for less (remember, sell high, but high works when you are trading DOWN, sell low, buy low works when you are trading UP, more people moving up - the American dream, a new baby, etc for now. Trading down will come when the feared Boomer starts retiring in 5 years). Thus, no good houses to buy, so there are still 10 offers when the good/priced right one comes on the market. Add all the grossly overpriced inventory where the sellers won’t price to market and there is no supply. Now, take high-end places like the Hollywood Hills or Malibu: a new reatining wall law in 2005 made building on vacant lots in the Hills harder and the billionaire are tearing houses on the beach in Malibu DOWN to combine lots and - once again - lower volume, but supply still gets dwarfed by demand. Add the last filter of “more people moving in than out of LA and its clear. I worry about places like downtown where the millions of empty feet/reantal feet can be converted to lofts at any minute. That will screw the curves.
Has anybody on this board touched on rents in So. Cal and how they signal a strong imbalance in the market. I rent in LA at the beach for $2000 (out of pocket). If I were to buy an $850K home which is a step down from what I live in today (which is roughly valued at $1 million) with a 20% down payment, my Property Tax: $566.00 ($885 per month at 1.25% before deduction, $566 lost after deduction) plus Interest: $2097.00 ($3277 per month at 5.9% before deduction, $2097 lost after deduction) plus Other Costs: $350.00 (insurance, maintenance, etc) gives me a Total: $3013.00 (out of pocket). The equity gained from my payment is a wash with the loss of interest I could have gotten on my downpayment of $170K. So I can rent a dwelling for $2000 or rent money to own that dwelling for $3000. This is not an exaggerated story. LA home prices are 10 to 15 times avg incomes. Traditionally 5 times incomes indicates the top end of the market and due for correction. Also home prices are 300 times rents. Today we have about 2.5% inflation. If Southern California home prices remained flat it would take 16 to 20 years for rents to catch up. When you have fundamentals like these, the benefits of home ownership literally evaporate.