Saturday, March 22, 2008

Who benefits from a real-estate boom?

I hate real-estate booms. I lived through one in the northeast in my early twenties. In 3 years, condo prices declined 30% from their peak. By another 3 years, they were down close to 50% from peak. Beth and I were happy to escape to the inexpensive and dull Indiana real-estate market.

We lived in Indiana for a decade. There, prices increased between 0-3% per year. Housing was very affordable, even in the best suburbs of Indianapolis. We sold our house there for almost no gain, and moved to Minnesota in late 2002, well into the real-estate boom. We bought a slightly nicer house here for way more money, I would say 30-35% more.

I cursed the boom even then, but there wasn't anything to be done for it. With school-age kids, renting wasn't an appealing option. At least we bought a couple of years before the peak, so it could have been worse. But it reminded me of the boom from the late 80s. People were saying all the same things:
  • "they aren't making any more land"
  • "when is the last time real estate went down in value??"
  • "stretch to buy as much as you can afford, it is a great investment"
  • "what other kind of investment can you live in while it goes up in value?"
I knew it was a boom, and wouldn't go on for ever. I won't pretend I knew how big the bust would be. I was hoping for the idealized "soft landing"--no outright price crash, maybe just years of stagnation, as incomes catch up to inflated housing prices.

The rest is history, of course.

So as I think about the real-estate boom and subsequent bust, I wonder who has benefited, and who has lost out. I don't think a full boom-bust cycle is a zero-sum game, with a winner for every loser. That might be true of a modest boomlet, when there are a few really strong years, followed by a return to normalcy. But a real bust also involves huge waste of economic opportunity.

So this is my quick analysis of who benefits versus who loses in a real-estate boom.

Farmers and other landowners. They clearly benefit, if they sell during the boom. That's an easy one.

Builders. It would seem like builders boom. They do lots of business, and their unsold inventory keeps increasing in value. Except. The longer the boom goes on, the more a builder is likely to expand. So when the bubble bursts, the builder is likely to have lots and lots of inventory, that sits un-sold for months. So I think builders may be more likely to get hurt, in the end, than to benefit.

Existing homeowners. We need to sub-divide this group. First, let's consider exisiting homeowners who bought before the boom, and continued to own their house through the bust. They never realized their paper gains, so they are clearly not big winners. But it might be worse than that. They might have been suckered into thinking that their house was their retirement plan, so they may have under-saved and/or over-extended. So in a sense, they may well have been hurt by the boom, even if all the fallout was based on decisions under their control.

Then there are existing homeowners who bought before the boom, and sold during the boom. Although it would appear that these people are winners, not necessarily. Most people sell and trade up, in which case they would be worse off. Even retirees often don't really trade down. So it would only be a small subset of homeowners who sell, who come out ahead. Those who sell and rent, or sell and leave for a less-booming real estate market. There will be a small number of people who have lucky timing: were planning to sell and trade up, but saw the market sliding after they sold, but before they bought; or sold because they were getting a 2-year expatriate assignment, for example.

First-time or out-of-town buyers who bought during the boom. They are losers--they paid more than they would have in a calm, orderly market.

Would-be homeowners. People who would like to become first-time homeowners, but either can't afford to in the hot market, or are just afraid of buying in a hot market. They are losers, though maybe not as bad as the above group, because although they would prefer owning to renting in reasonable market conditions, the frenetic market keeps them out.

Parents of young adult children. Even if you are thrilled to see the value of your own house go up, is it really so great if your adult children can't afford to but their first house?


  1. It's a great question.
    "Then there are existing homeowners who bought before the boom..."
    -- But they usually then buy a house as well unless they are real investors.
    So maybe in the end (other than vacant land onwers)the big winners are realtors who plan and save well, short term real estate investors, builders who scale down correctly with the market and mortgage brokers.

    A happy continous medium is obviously ideal but capitalism and greed gets in the way sometimes.

  2. Great point, Paul. I updated my post to take it into account.