Three phases of a real estate bubble

“Comparing actual selling prices though, the market has not dropped. For example the last property sold for $300,000 and this one also sells for $300,000 (but was originally on the market for $360,000). In actual fact there is no crash at all. The public make a mistake when they read price reductions in advertisements to mean that actually selling prices are also reducing.”

You have only described Phase I of a crash.

In Phase II, the speculation premium disappears from buyers’ willingness-to-pay, as they become aware that those anticipated 20% YOY gains you refer to were a mirage. At that point, the real air goes out of the prices, and valuations adjust downwards from where they were at the height of the boom when anticipation of untold future riches artificially inflated valuations.

In Phase III, the drop in price from Phase II comes to light, and the downward movement in prices gets taken into consideration, setting off a tail-chasing correction of valuations back to fundamental levels or lower.

Stephen Stohs
Economist

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