While I have a notable bias towards real estate, it is factually incorrect to state that this asset class is immune to volatility and corrections. We recently had one of the longest real estate corrections, and are only now coming out the other side.
As real estate operates like other asset classes, it is important to understand the drivers for its cyclicality.
Market sentiment, not fundamentals, is what leads to corrections
At its core, the real estate market operates similarly to any other free market. There exists a population of buyers and sellers. Both parties wish to transact over a good (property), presumably on an arm’s length basis.
An oversupply to the market would suggest that house prices remain stagnant and may fall. Alternatively, a lack of supply would indicate an upward trend in house prices, at least in the short-term. External stimulus, such as government incentives and grants, will likely pique demand conditions, which will also influence home prices.
Like other markets, the real estate market players are subject to asymmetric information. This imbalance creates a disconnect in the market, such that homes are sold for a much higher or much lower market value. Moreover, a lack of misinformation or incomplete information may lead buyers and sellers to operate in a manner that is inconsistent with the fundamental view.
Despite our best intentions, we are emotional beings. We allow our decision process to be clouded by factors that are not directly pertinent to the decision to be made. Therefore, we are quick to act on impulse, which may result in us buying a house for more than market value, or selling it for less than it’s worth.
The media is an effective accelerant for market sentiment
The general public, while broadly educated and possessing reasoning skills, are not real estate experts. I’m not saying this to sound arrogant or to cause offence. The truth is that, if everyone operating in the market possessed all requisite information, then the market would operate perfectly and there would be no such thing as a boom and bust.
Instead, the general public relies on free and widely available information. For example, news posts or media segments provide details on the overall condition of the market. However, it is worthwhile noting that newscasters intend to evoke a certain reaction from this information.
Typically, that reaction is one of frenzy or panic, which are effective motivators. This frenzy may lead the general public to either inflate or deflate the market.
the FOMO effect Also Plays Its Role
Sometimes a market event or economic change may arise that can fundamentally shift market sentiment into a frenzy. In my opinion, COVID-19 presented one of these events.
The Australian government took swift action to insulate the economy, from stimulus checks, rent eviction moratoriums, and increases in housing incentives. This sufficiently piqued the general public’s interest in home ownership.
As more people availed themselves of the incentives, others were left concerned that these opportunities won’t come around again, and that they may miss out on the chance of a lifetime. This is despite their own personal requirements for a change in housing.
This in turn sharply increased housing demand and median home prices, and resulted in material construction delays (as discussed here).
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Real estate, like any other market, has inherent volatility. It should theoretically move in alignment with market conditions that drive supply and demand. However, I maintain that individual sentiment plays a bigger role in the overall market performance, and will certainly influence a market’s pathway towards boom or bust.
The content outlined above was written, edited and published by the Lost Realtor. The author has over 20 years or real estate sales and investing experience in the Australian property market. He has held senior positions in Australian building companies, including being the General Manager of the residential sales division of Collier Homes. His qualifications include a Bachelor of Commerce degree and a Graduate Diploma in Building and Construction Law.