Blessed by the Potato

I’ve mentioned speculative holding before as something that underlies a bubble, but haven’t really gone into any depth on the subject. Basically, it’s a speculative behaviour that isn’t as obviously speculative as buying something purely in the hopes of future appreciation: instead you hold something you may have bought for other reasons on that hope.

One of the more typical examples is to hold on to an old property to rent out after you buy a new place to live in. The purchase you make at the time may not be speculative, but often the decision to hold on to excess property is — if you weren’t counting on large future gains, you would have sold off the old place, rather than take the risk and hassle of becoming a landlord.

Less obvious is buying preconstruction while owning. Even if you plan to sell as soon as the new place is finished, you have double the real estate exposure for the duration of the construction, which could be a few years. When people are advised not to time the market, that means they should be selling a their old place as soon as they buy a new one — even if the new one isn’t built yet — in order to limit risk. Many may chafe at that advice, in which case they shouldn’t speculate in the preconstruction market unless they have the capacity to take on the risk, and instead shop around for homes that are already built.

One of the more subtle effects on supply is the decision of whether to buy first and then sell, or go the other way around. Deciding to buy first then sell has a small effect on supply and is like a minor version of buying preconstruction (for a time you are exposed to double the risk). It is a small effect, and the market adapts to whatever way is accepted as the norm (or even some mixture of methods). But when the shift happens from one scheme to another en masse, it can sway the supply. Take the case where everyone considers that the way to transact in real estate is to buy your new place first, then go out and list the old one. If then everyone changes their mind, perhaps deciding that the market is softening and the old way was too risky, and sells first, it could shift months of inventory over all at once: suddenly new houses are coming on the market while inventory sits. If “the” way to transact is different in a “buyers'” market than in a “sellers'” market, then once the shift is proclaimed, it could lead to a short-term swing in inventory and put pressure on prices.

I think one of the largest effects of speculative holding is the shift that occurs in the supply curve under the influence of rising prices, the holding on in the face of steady price increases. Imagine if someone comes out of the blue and offers you $1M for the house you paid $500k for just a few years before. Many of you would be all over that deal, telling your neighbours about it who would rush out to list their houses and take advantage of the opportunity. You’d think the buyer was nuts and that it was a one-time, not-to-be-missed opportunity. Hey, you could go move to the next town over (where houses were still $500k) and practically retire on that kind of money. But if you got to the $1M offer via a succession of offers: one at $550k that you turned down, then again a bit later the buyer comes back to you offering $600k, then again a few months later with an offer of $650k… by the time you got to $1M in a few years, you would have been expecting that price, and possibly even projecting out to the $1.2M offer you were sure was in the works for you. The price itself was still just as insane, just as much of a windfall, but because of the path to get there you’re less likely to actually put your house on the market and take it. You were inoculated against the crazy, so it seemed right.

And finally, the incarnation of speculative holding that made me think to write this post: taking the house off the market for “when it recovers in the spring”. Sales in Toronto and Vancouver dropped double-digit percentages over the past year, to the lowest levels since the financial crisis. Prices barely budged, but were down a bit in many sectors. Thus it’s quite common to hear on the subway, in the restaurants, the newspaper articles and the chat boards that famous idea of trying to relist later when the market looks better. That is perhaps the baldest speculative holding of all: the person wants to sell, but will hold on in the hopes of higher prices later.