by Cassandra Majors, Independence Title
Ever since the meteoric rise of Austin’s real estate market in the last two decades, I’ve heard the same question asked in many different ways, from many different people. It usually takes one of three forms:
1. Is Austin in a real estate bubble?
2. When will Austin’s real estate bubble finally burst?
3. The latest data shows [insert statistic here], which is not as good as before, so does this mean the bubble has finally burst?
If you don’t feel like reading much today, I’ll make the answers quick for you and leave the explanation for those of you with more time on your hands. Here are the answers:
2. It’s not a bubble.
For the rest of you still with me, let’s dive deeper. Why is Austin not in a bubble?
Wander with me down to Florida to understand what a real bubble looks like. Don’t be scared–we’re going to Florida in the 20s, not Florida today. In the early 1920’s, the Florida real estate market was the hottest in the country. From coast to coast, advertisements filled with sunny white-sand coasts beckoned eager investors to the Sunshine State. Land values skyrocketed with such force and velocity that buyers could often expect a bountiful return on their investments in a matter of weeks. One historian illustrates the fervor with this example: “In Miami Beach, lots near swank Lincoln Road that Realtors listed for less than $7,500 in June 1925 commanded a price of $35,000 42 days later.” Not that impressed? Putting this increase in a current perspective by adjusting for inflation, that example is the equivalent of buying a $100,000 lot in Austin in June this year and then selling it in August for $467,000. Wow! How could investors resist those kinds of returns?
For anything you own, be it a house, a car, a fidget spinner, or a horse, there are two ways to measure its value. The use value, which is what the object is worth for you to actually use, and the exchange value, which is what you can get for it if you sell it. I can use a horse or a fidget spinner for riding or spinning (respectively, let’s hope), so they both have a certain amount of use value for me. If I need that horse not just to ride for fun but also to help me for working my ranch, its use value for me goes up even more. If I sell the horse to my cowboy friend (I’ll throw in the fidget spinner for free), he pays me the exchange value price. If the horse market goes up or down but the horse stays healthy, the cowboy loses or gains exchange value, but doesn’t lose use value. He can still use the horse even if horse prices go down; he just won’t be able to sell it for as much.
Real estate is no different. I live in a home and it provides me with shelter, warmth, and Netflix. So long as it’s livable and I have a rock-solid Independence Title insurance policy, it will always have value for me, but its exchange value will go up and down depending on market forces. Real estate bubbles happen when the exchange value of properties in a certain area become completely unhinged from the use value. As they did in 1920s Florida, investors don’t buy properties to live in or to rent out for income, they buy them for the sole purpose of holding onto them for a relatively short period of time before selling them at a steep profit. This is the simplest explanation of what speculation means, and a speculative market is THE thing that inflates the dreaded bubble.
It’s not hard to see why speculation hurtles a market ever closer to disaster—without a concern for use value, prices inflate artificially as one investor sells to another who sells to another and so on. No one is thinking about what happens at the end, they just want to buy and sell as quickly as possible. Then one day, something bad happens—the economy tanks or a natural disaster hits the area, for example—and all of a sudden, prices take a spectacular nosedive overnight. If you’re the unlucky one who just bought, you’ve just lost the game of Real Estate Speculation Hot Potato. The music stopped and you’re the one holding the potato…and no one wants to eat the potato anymore.
In Florida, that’s exactly what happened. The state ran into supply issues from a dispute with the railroads, had a shipping disaster block off a major port, and experienced some bad weather that destroyed many properties. In a heartbeat, the entire market crashed, investors lost millions, and the state’s economy took years to recover. And this little microcosm is actually a great way to understand the stock market crash in 1929 that preceded the Great Depression—the stock market was going up so fast that investors just had to buy and hold stocks briefly before they could sell at a wildly inflated price. The value, profit, and long-term prospects of the companies didn’t matter much, so what investors were actually trading was the delusion that prices would keep going up forever. And you already know how that story ended. Whenever pure exchange value becomes the driving force of a market, a crash always looms ahead.
Now you might say I’m just reaching for the low-hanging fruit by finding the most obvious example of an out-of-control bubble. But I really want to reveal the conditions that lead to a bubble, no matter what the size or severity, and the Florida land boom is a great way to see those conditions and see if they apply to Austin today. What are the conditions that create a real estate bubble? They’re easy to identify, but often difficult to see in the moment:
• Rapidly appreciating home values
• Easy and generous credit for buyers
• “Irrational exuberance”
Let’s go down the list. Do we have…
Rapidly appreciating home values? Check! Uh oh! But let’s keep going.
Easy and generous credit for buyers? Not so much. As we learned in 2008, when it’s easy for unqualified buyers to borrow large amounts of money, it leads to a collapse of our market that many parts of the country and world are still reeling from even today. In the U.S., new regulations and lessons learned by financial institutions have made getting a loan much more difficult. Loans for large commercial and development projects are even more difficult to secure.
Irrational exuberance? This is a term originally used by Robert Shiller and referenced by Alan Greenspan during the dot-com bubble in the 90s, and it describes a market with so much activity and enthusiasm that it quickly becomes overvalued. In Austin, yes, we’ve had some exuberance, and now we’re seeing that glow slightly fade a bit as prices stabilize. On the whole, however, home values are still appreciating nicely and our population is still booming, so our exuberance can’t really be described as irrational.
Speculation? Definitely not, and this is really the crux of the argument. Can you buy a house in Austin and sell it for a profit a few months later? A year later? In some cases, yes, but your returns are limited by significant closing and mortgage costs, higher property taxes, and all the costs associated with maintenance, improvement, and selling. Values have gone up a lot and quickly, but still very much within the reasonable bounds of supply and demand. Remember that speculation occurs when the use value and exchange value become unhinged from one another. People are moving here to live and work, and mostly buying homes for themselves and their families to use, not as an investment to sell quickly. Sure, you can buy a fixer-upper and flip it for a higher profit, but you’ve increased the use value of that home along with the exchange value. You didn’t just buy a dump and wait a few months to sell it for profit leaving it in the exact same condition. In the Florida land boom, many properties exchanged hands over and over with none of the investors ever having seen the property or even having been to Florida at all!
Will there be a day when we have a national economic downturn or a natural disaster and Austin real estate will suffer as prices drop? Yes, of course. But that is NOT a bubble bursting—it’s just an inevitable outcome of the economic cycles we’ll all have to live through in the course of our lives. Though there were (and still are) some pockets of speculation in our market, especially in the early days, it has always been a small percentage of the overall market. So long as people still want to live here and can find jobs, our housing market will always recover when the economy gets better. In an actual bubble, homes never truly regain their value, because their values were an illusion, completely disconnected from reality. In contrast, Austin’s reality has been a journey towards becoming an ever-more important, major American city with a great local and state economy, low unemployment, and booming industries. And people also just like to live here because central Texas is a wonderful place to be. So don’t fret about a bubble that doesn’t exist—Austin will continue to provide intrinsic use value for those of us lucky enough to call it home.
Cassandra Majors has been a market analyst and data guru in the Austin real estate industry for over a decade.