Secret #14 – Higher House Prices Can INCREASE Current Demand

The Ignored Economic Fundamental – Price Expectations

People's expectations for future house prices determine, to an important degree, current demand. People who expect prices to increase in the future, especially in the near future, want to buy sooner rather than later, and they are less sensitive to price. Higher price trends lead to higher demand and higher prices today. Lower price trends lead to lower demand and lower prices today.

The increase (or decrease) in demand caused by future-price expectations can cause house prices to increase (or decrease) even more in a feedback loop.

The Most Powerful Force in the Universe – Inertia

• Higher prices tend to lead to higher prices. 

• Flat prices tend to lead to flat prices.

• Lower prices tend to lead to lower prices. 

Economists say “fundamental” economic factors, such as changes in interest rates, household income, and population determine house prices. For some unknown reason, economists don’t consider people's expectations for future house prices to be a fundamental factor determining current house prices – but they should. 

Economists have done a ton of research on this general idea. Unfortunately, they call it a ton of different things which is very confusing. The general idea has been called: 

• price expectations, 

• price extrapolation, 

• biased expectations, 

• adaptive expectations, 

• diagnostic expectations, 

• errors in expectations, 

• irrational exuberance, 

• learning from prices, 

• momentum trading, 

and other names.

Despite all the different names, the idea seems obvious: If you expect house prices to be higher in the future, you are, naturally, less willing to sell now, more willing to buy now, and more willing to pay above the current market price for a house. 

Expectations of higher prices in the future cause house prices to go up even more rapidly, which causes people to become even more confident prices will continue to go up, so prices continue to spiral upward. 

To some degree, higher prices lead to higher prices.

“A puzzling and prominent feature of housing markets is that aggregate price changes are highly positively autocorrelated, with a one percent annual price change correlated with a 0.30 to 0.75 percent change in the subsequent year (Case and Shiller, 1989). This price momentum lasts for two to three years before prices mean revert, a time horizon far greater than most other asset markets.

“Since the pioneering work of Case and Shiller (1989), price momentum has been considered one of the most puzzling features of housing markets. While other financial markets exhibit momentum, the housing market is unusual for the strength of the effect and the horizon over which it persists.” Guren, 2014.

House price increases (or decreases) in recent years determine to a large degree what people think will happen to house prices in the future, and their willingness to buy today.

But since economists can’t get hard numbers for it, economists tend to ignore future-price expectations.