When a community is caught up in a speculative mania, it seems simply inconceivable to the vast majority that prices could drop. If apparent hordes of buyers are competing to paying $1M, $2M, $3M for solid assets like houses, how could prices possibly plummet by 40%, 50%, 66%? It just couldn’t happen, surely… why would a group of people who’ve ‘agreed’ (via market pricing) that a house is ‘worth’ $3M, then ‘let’ it change hands later for $2M or $1M or even less? Surely buyers would ravenously step in at even 10-15% off [the commonest estimation of the depth of a pullback on this and other blogs]? Surely that ‘wealth’ can’t simply evaporate?
But it can and it does and it will. Most people don’t have any real feel for ‘bubble dynamics’… they don’t understand the massive upward force that expanding credit has on asset prices and, more important, the devastating effect of the reversal of that process.
In an article at ‘Elliot Wave International’, a passage by Robert Prechter describes ‘How $1-million can disappear’ [19 Sep 2011] We take the liberty to paraphrase the passage here to demonstrate it’s relevance to our RE market. -
“The dynamics of value expansion and contraction explain why a bear market can bankrupt tens of thousands of people. At the peak of a credit expansion or a bull market, Vancouver homes have been valued upward, and all participants are wealthy — both the people who sold the homes and the people who hold the homes. The latter group is far larger than the former, because the total supply of money has been relatively stable while the total value of Vancouver RE has ballooned. When the market turns down, the dynamic goes into reverse. Only a very few owners of a collapsing asset trade it for money at 90 percent of peak value. Some others may get out at 80 percent, 50 percent or 30 percent of peak value. In each case, sellers are simply transforming the remaining future value losses to someone else. In a bear market, the vast, vast majority does nothing and gets stuck holding assets with low or non-existent valuations. The ‘million dollars’ that a wealthy owner might have thought he had in his home at peak value can quite rapidly become a small fraction of that. The rest of it just disappears. You see, he never really had a million dollars; all he had was an asset that he thought was worth a million dollars. The idea that it had a certain financial value was in his head and the heads of others who agreed. When the point of agreement changed, so did the value. Poof! Gone in a flash of aggregated neurons. This is exactly what happens to most assets in a period of deflation.”
Housing always has some underlying fundamental value, we don’t believe that a $1M [circa 2011] Vancouver home can drop in price to “non-existent valuations”… but we do foresee it dropping below $500K or even $400K later this decade. It may seem inconceivable, but history teaches us that it is very possible; probable, even. – vreaa