Fast-rising prices attract speculators who are “momentum investors”. Their goal is to make a fast profit by flipping the property within six months. The entry of speculators adds demand for homes, ordinarily the arena of end users (households) and long-term investors. Speculators, while interfering by adding to demand, cause prices to rise faster and further than had the market been dominated solely by users and landlords, clear signs an asset bubble has developed.
Soon the user, as the necessitous buyer, leaves the market. They look to rent an apartment (or a house from a speculator) as a favorably priced alternative to owning over-priced property.
To sustain the ability to speculate and make a profit on the momentum, the supply of housing must remain tight – no listing can remain unsold after 60 or so days on market.
Builders – and recent buyers – are the biggest losers when a real estate bubble bursts. The inventory of unsold new homes must then be sold at greatly reduced profits, some even at a loss. Builders have incentive to avoid what will in some cases be inevitable losses if the speculative prices go on too long. Yet as long as speculation absorbs homes to be held vacant, juicy profits are to be had.
Builders at the right moment – before too many speculators drive prices too high and end users become entirely discouraged – must begin limiting construction starts and ban speculators from the purchase of any of their homes. Starts are limited to the level of sales demanded by homebuyers. If done, builders will keep operating overhead and the inventory of unsold homes to pre-boom levels, a trend line set by buyers who occupy the property as their principal residence.
This strategy would produce juicy profits on each home sold, but not the excess profits generated by building even more homes and selling the extras not purchased by users to speculators at seemingly ever inflated prices. When the end users eventually revolt against the payment of excessive prices, the builder who has banned speculators for the prior six to twelve months is doubly insulated against the resulting drop in sales volume. He can cut prices, reducing or eliminating his profit, and sell below the competition, be they other builders, resale homeowners, or speculators – putting the buyer back into his market. Since the late 19070s, purchase-assist loans have always been available to qualified buyers.
Also, an operating overhead based on construction for sales only to end users can be quickly adjusted to fall back on reduced sales. Without speculator-owned housing, the nasty adverse effect of foreclosure within his unsold tracts on homes due to the speculator’s failure to be able to flip for a price greater than their mortgages has been avoided.
A tantalizing economic result of limiting new construction to supply homeowners only is that a scarcity of homes in a speculator-driven market lengthens the period of price rise and increased profits on inventory before the inevitable arrival of the crash.
For builders, this temporary period of juicy profits should prudently be used to build up cash reserves. As a benefit for banning sales to speculators, the builder’s operations and employers are more insulated from any drastic adjustment needed to remain viable when supplying housing to fill the needs of households that will be formed and which will buy homes if the price is right.
Brokers, if they could organize their agents to act in their own best self-interests, would refuse to take listings on properties unlikely to sell within a two- or three-month period on the market. Any property listed at the height of a speculator-driven rise in sales volume and prices sells quickly. At the peak of activity, sales conditions experience an auction environment with the high bidder paying more than the listed price. The high bidder often acquires the property as a speculator, not as an end user who will occupy it.
When users decide it is futile to make offers, sales volume drags and the inventory of unsold listings will start to stack up. It is at this point that a three- or four-month supply of inventory builds up. Brokers should instinctively draw on their understanding of the economics of supply and demand and cut back on listings, accepting employment to market only those properties which will sell within two or three months. If they don’t, they will be smothered with excess property to market at unattractive prices.
Worse, prices are driven down unnecessarily when a sales pace of unsold inventory exceeds a four- or five-month supply. An inventory backlog of ten or more months of sales produces a mental and emotional backlash among buyers causing fewer to buy as they wait for prices to drop even further.
But some brokers weigh their prospects of earning fees on having the largest number of listings in the industry, a sure sign of likely failure in a real estate recession. Possibly, it is time the title of “Listing Agent of the Month” and awards given to top producers of property listings to be revised to the ignominious title of “Agent Contributing Most to the Broker’s Forthcoming Chapter 11.”