Yet Another Word About The Real Estate “Bubble”

By: Wojciech Kic

In an everyday conversation about residential real estate, inevitably a common question arises regarding current values.To many observers real estate values are past their peak awaiting a downfall. In the opinion of others the climb toward the higher values is not yet over.

These observers are divided into two opposite camps: buyers and sellers. While to the buyers and to the sellers the opinion of the present dollar value of the sale transaction is always the same, the opinion of the future dollar value of the asset differs symmetrically. The buyers buy because in their opinion the future value is higher; the sellers, on the other hand, sell because they believe that the future value will never be this high again. The distribution of the decisions is a statistically perfect 50/50.

Which of the residential real estate market participants are wrong? What factors determine who is drinking from a glass that is half full or half empty?

The residential real estate market has experienced a tremendous change since the early 90s. Using Houston as an example, while populations of suburbs continue to grow, the demand for the inner city living is now a measurable force.The inner city is undergoing rejuvenation and its population base is growing.The popularity of inner-city areas has not been this strong in generations.The future seems so bright that the owners of land on the edge of downtown eagerly await the arrival of the residential developer. And it is in the absence of the office building developer that we find many answers about the strength of the residential real estate market today.

The advances in technology, most notably mass acceptance of the Internet, tremendously expanded the productivity and flexibility of the work force. Much valuable work is now done at home; it is easily delivered anywhere via the Internet. Also, globalization transferred production capability to other countries; the economic liberalization of much of the world expanded production infinitely. As a result economic decisions are no longer based on the anticipation of scarcity; the principle of substitution makes all types of goods not only available but affordable as well.

The future looked different in the 60s and 70s. Downtown and near downtown land was “held” in reserve for office building developers. Residential owners were uneasy about residing downtown.They were unwilling to invest in a future that clearly belonged to commerce. It is not that the residential real estate owners suddenly developed an affinity for long distance freeway commutes. But the decision to flee the inner city had to be rationalized and it was.

Soon the downtown flight became part of self fulfilling prophesy: new schools, new golf courses, and of course, shopping malls opened in the suburbs. As more residents left the inner city they left behind residential infrastructure.The abandoned schools and malls in the inner city often became unsellable.Vagrancy and crime found an opportunity. Living downtown became impossible. Suburban flight became a social divide.

The current message from residential real estate market buyers is that the current supply of commercial buildings downtown is more than sufficient to meet the foreseeable futures needs. All downtown land, previously “held” in reserve for office building development is now “offered” to the residential developer.The century of dominance by the office building developer is over.

Thus, the ever-increasing economic production capacity changed the rules and left behind an absence of buyers and an excess of sellers. Where the principle of substitution does not apply, however, is in residential real estate. Still, the emerging abundance need not lead to a loss of common sense.

As far as the future goes, it is obvious that the expansion of the economy will be reflected in corresponding gains of residential real estate values.The rate of the gains can only be hampered by the speed of economic transformation.

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