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This is How The Real Estate Market Will Crash (2022)

We need to address this once for all. There is a way that the market will collapse, but I am telling that now (as far as the informations we have), this is not it. But since everyone is trying to crash the market, I will tell you how it would happen.

It's the Economy Market, Stupid (Part I)

No, I'm not calling you stupid. That's the notorious phrase said in the Bill Clinton 1994 campaign War Room. Everything is about the market, and it responds to two things, and two things only: Supply and Demand.

You see, the price of any kind of good and service, from money to space travel tickets, are controlled by the free forces of how many people are willing and have conditions to buy it, and how much companies can provide that, giving their costs and profit margin (considering we are not in North Korea, or Cuba, or any other centrally controlled government).

This is How You Do Groceries

When you go to the supermarket ready to do groceries, you have a bunch of conditions that you cannot change, but will have an impact on your decision: your salary, your rent/mortgage, all the other expenses you must have that are not in the supermarket (so you need to save money for them), how much money you are saving, etc. With that in mind, you will buy more or less itens in the supermarket according to their price: if they are more expensive, you won't buy 3 bottles of wine, you will buy just one. This is what we call the Demand Curve, and it is like this.

The demand curve shows that when, given certain conditions and those conditions are constant (we called ceteris paribus), as the Price of a good or service goes down, the Quantity consumed goes up, and vice versa. That's one side of the equation. The other one is the supply.

You Are Not Important

The same way we decide how much to buy of something base on the conditions we have and the price of that something, companies decide to produce (offer) their goods and services based on their conditions (costs, labor, interest rates, taxes, incentives...) and the price people are willing to pay for it.

If, given certain conditions, the company can sell for more, which would increase their bottom line (a.k.a Profit), they will be incentives to increase the supply. If people are willing to pay less, less companies will be in the market and the prices will go up.

We see that happening with airline companies all the time. When a company buys another one, the prices of fly tickets go up, because they reduce the number of flights available, the supply.

So, the Supply Curve has a different shape of the Demand Curve, looking like this.

On the Supply side, given the conditions, the higher the price, the more companies will offer of a given product and service.

It's the Economy Market, Stupid (Part II)

Unfortunately, despite what my mom told us, in the Economy Market we are not special, and companies don't set their price base on individuals, but on the whole bunch. Consumers are not the weaker part of the equation, though, because if one company sells the same product as the other for a higher price, we go the the cheaper one (considering they are equal).

So, when we overlap the Supply Curve with the Demand Curve, we find the miracle of "Market Price", which is the price that puts the market in balance, just like this.

This is where things start to get interesting. If companies decide to raise the price, but the consumer conditions (Demand Curve) stays the same, look what happens.

As you can see, the Demanded Quantity (QD) for that given price (P1) is lower than the Supplied Quantity (QS). And when that happens, there will be extra itens of that goods flying around the market, and companies will do what to sell them? Promotions. They will decrease the price to end the extra supply, and the market shall come to an equilibrium again.

But, what happens when the conditions of the de Demand or the Supply change? Let's work on an example.

When unemployment rates go up, there are less people able and willing to purchase a given good or service. Also, when the interest rates goes up, that also changes how people consume, for two reasons: 1) it's harder for them to qualify for a loan and 2) it's better to save money (and get interests) than spending money. And Vice Versa. This how it would look like.

Let's say the conditions of the demand were increased, by the Federal Reserve lowering the interest rates, or the Government would send you money via a check to your mailbox, etc. Now people are more incentivized to spend money, rather than saving it. The Demand Curve would change, from D1 to D2. The companies now, because they couldn't increase their supply capacity in the same speed, to offer more products, would increase their prices, to keep the market in balance. If the demand conditions were decreased, by increase of interest rates, by increase of unemployment rate, or whatever, now people would buy less and prices would go down.

This is Why This Time Is Different

The definition of a Market Crash is "a sudden and significant decline in the value of a market," according to Investopedia. For that to happen, you need a combination of a abrupt change in the Supply side and in the Demand side. And that's what happened in 2007-2009. The Demand side was affected because banks completely stoped lending money. And as the Average Joe was buying 5 houses with 0% down, with No Income, No Job, no Asset (the famous NINJA loans), now he couldn't buy anything. Not a single property. And that's was the Phase 1 of the crash.

The Phase 2 was affecting the Supply side. Since 99% of construction is done using finance, builders and developers stopped offering more properties. Also, the banks had taken out of the market hundred of thousands of properties, due to foreclosures.

In 2007 we had extreme conditions working both on the supply and demand sides at the same time, which led to a massive decrease of prices (from P1 to P3) in a short period of time. That's a crash. And that's not at all what's happening now. The demand for properties is still high and the supply capacity is low (it takes time to build a house or a residential tower). What the Government is doing now is, by increasing the interest rates, reducing the conditions for general demand of housing, causing a modification on the Demand Curve which could, in a certain amount, reduce the total sales and, if there's too many properties in the market, reduce their prices. But I cannot see an "sudden and significant decline in the value of a market", because:

  • 38% of homes in America don't have mortgage

  • the average equity in a property is $188k

  • The total owner-occupied residential market cap is $41 trillion and the total equity in homes is $29 trillion (70% equity)

  • 9 out of 10 mortgages are fixed

  • 50% of mortgages are fixed under 4.4% rates

  • 99.5% of homes are owned by "mom and pops" (not institutional investors)

  • 2.1% of homes in America has negative equity.

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