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The Supply Curve in Residential Real Estate Bubbles

By: Alex Gwen Thomson

The supply curve is the opposite of the demand curve: sellers will make very few units available at low prices, and sellers will make a great many available at higher prices. Wherever these two curves meet is where supply and demand are in balance and market transactions are taking place.

In the initial stages of a market rally both transaction volumes and prices are increasing rapidly. In states with a cumbersome entitlement process like California or in the Northeastern part of the country, delays in bringing supply to the market exacerbates the initial price increase and ignites the speculative frenzy.

During the Great Housing Bubble, an increase in demand was caused by a dramatic expansion of lending and credit. As a price rally matures sellers become reluctant to sell because the asset they own is appreciating rapidly, and they do not want to miss the opportunity to profit further. This limits the supply on the market. In terms of the supply and demand diagram, this shifts the supply curve to the left which pushes the balance between supply and demand to a higher price point. The demand curve shifts to the right from the increased liquidity of the lending environment and the supply curve shifts to the left because of seller reluctance; the intersection of these two lines moves prices markedly higher. However, once these two forces come into balance, their intersection is at a point of low transaction volume. There are fewer buyers who can afford the higher prices, so transaction volumes fall.

The first sign of a troubled real estate market is a dramatic reduction in volume known as buyer exhaustion. There are simply not enough buyers able or willing to push prices any higher even at the lower transaction volumes. In a residential real estate market, this phenomenon is particularly pronounced at the entry level. The imbalance between supply and demand first becomes apparent at the bottom of the affordability scale with entry-level buyers because these buyers are not bringing the profits from a previous sale with them to the next property. Affordability is less of a problem for existing homeowners in the move-up market due to this equity transfer.

When affordability becomes very low, transaction volumes wither, and prices stop their dizzying ascent. This is the first sign of the top of the housing market. In 2005 and 2006, affordability was at record lows in many markets across the United States. This signaled the end of the bubble rally and the beginning of the deflation of the Great Housing Bubble.

Article Source: http://familygardenhome.com

Lawrence Roberts is the author of The Great Housing Bubble: Why Did House Prices Fall? Learn more and get FREE eBooks at: www.thegreathousingbubble.com/ Read the author's daily dispatches at The Irvine Housing Blog: www.irvinehousingblog.com/ Visit The Supply Curve in Residential Real Estate Bubbles.

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