Property Bubbles and Market Crashes

In previous chapters we have seen that it is almost impossible to understand, let alone predict, property prices. One of the underlying reasons for this is that real estate, like the economy in general, suffers from bouts of over confidence and under confidence.

In the good times most people start to get carried away. They buy shares because the stock market always seems to be going up. They buy property because newspapers report ever rising prices.

To start with these increases are real. As a country moves out of recession wealth is created allowing values to improve. At some point however there is too much confidence. Like the casino visitor on a winning streak, its hard to stop. This is not just in property, but in everything. The business cycle is moving into it's boom period.

Eventually there is an event, such as the global credit crisis of 2008, which shakes confidence out of the system, and a bust occurs. Shares slide, property prices sink and the economy moves into recession.

Now, en masse, the population is under confident. Concerned for their own lives and financial security they become over cautious and everything from the stock market to an apartment's selling price are below what they should be.

But economies move on and confidence returns to start the business cycle all over again.

Economists have, for nearly one hundred years, been trying to find a formula where steady growth can be achieved without the booms and busts but it is an almost impossible task given the emotional swings of human nature.

Speculators have also been trying to predict exactly when the bust will happen with, as we have seen earlier, the same success as the economists - very little.

Investors in stocks, shares and properties try to guess when should be the best time to sell. When has confidence taken over from reality and when will there be an event or moment that causes this confidence to be removed. Some manage it, some are lucky, some are not.

No matter what is printed on these pages if you own one property or a portfolio and prices are rising it is difficult to make that selling decision. If it were easy there would not be booms or busts.

Property Bubbles

Bubbles are often confused with booms and crucially property booms are often misreported as bubbles.

For a property bubble to occur real estate must be over valued by the market in isolation. If, in 2008, the economy had continued to grow but house prices had started to drop then it could be said that there had been a property bubble.

A perfect example of a real bubble was the route that dotcom shares followed in the late nineties and at the start of the millennium. There was an over confidence in what internet companies could achieve and a strange concept that the more money the company lost (known then as its "burn rate"), the better it was.

Investors and individuals piled in driving the share prices of online companies sky high, a bubble was occurring. The burn rate theory might have been right, this was new technology and virgin territory. But it wasn't, investors pulled out, the bubble burst and share prices for many internet related businesses plummeted.

Crucially this happened with little affect on the rest of the economy. On it's own it can sensibly be called a bubble.

Understand the difference between and boom and a bubble and you realize that there has never actually been a property bubble in the UK. In the early nineties houses prices fell as the economy moved into recession and rose as it came out the other side. The same events followed the 2008 downturn. British and London property follows the business cycle of Boom and Bust rather than Bubble and Burst.

This is not to say the property bubble concept isn't valid but it tends to occur more on a local scale. In some Bulgarian resorts for example foreign investors were carried away with rapidly rising apartment prices. Property moved beyond the reach of the local population and when these buyers from abroad began to loose interest, the bubble burst.

The bubble problem can also happen to a specific type of property. In 2001 the London borough of Clapham was tipped as the next hotspot. Young professionals keen to take advantage rushed in looking for two bedroom apartments in particular. This drove the price up to around L250,000.

It gradually became clear that Clapham was up and coming, but not that quickly, the bubble burst and two bedroom apartments lost around ten percent of their value. A similar situation in 2004 pushed the price skyward to L270,000 but only for around eight weeks before sinking back to the same value they had been selling for three years previously.

When the Figures Loose Their Meaning

All statisticians will tell you that in order to get a good average you need a great deal of data. For this reason market researches ask around one thousand people in a cross section of the population how they might, for example, vote at the next election. But even with this large sample they realize the figures could be wrong and hence the small note by every graph which reads something along the lines of "degree of error +/- 3%".

Next time you see a pole which says 45% of people support the Conservatives and 40% support Labour remember it could just as easily be 42/43.

The same is true of property prices. Monthly reports will show wildly fluctuating data on a local level if most people aren't moving as was the case in 2008. On a national level the number of sales dropped from well over one hundred thousand transactions to just a few thousand.

And with every decrease in transactions the possible degree of error increases. This is then compounded by the actions of supply and demand. If sellers don't want to sell or don't need to sell prices will not move down to meet demand. They will wait for demand to recover and move up again.

However the few who do need to sell must drop to meet demand and these are the reported figures. They are however misleading if the majority of sellers would not offer their property to the market at this level. Property has no "sell by" date and so the economic theory of supply and demand can become shaky or even stop functioning in any meaningful way.

Summary

Booms and busts are difference from bubbles and bursts but they are often mixed up by the media. In Britain there has never been a property bubble which burst on a national scale but it has happened locally. Property prices instead follow the booms and busts of the business cycle and a way to predict this accurately has yet to be found.

Looking at the statistics can be misleading if there is not a high volume of sales for any given area or geographical region. They can also paint an uneven picture if sellers do not want to sell.