The Herd Effect

Californians flush with home equity due to the astronomical rise in home values in their state over the past five years are now influencing many of the surrounding markets including Phoenix, Las Vegas, and parts of Oregon. Home values have increased so drastically over the past five years that many are borrowing upwards of $200,000 on a second mortgage, or a home equity line of credit and paying cash for starter homes in these other markets. It is this speculative investing that is driving home prices up in those markets. While this is great for those investing, it only worsens the situation for prospective first time homebuyers in those markets.

It is reminiscent of the tech bubble that burst in April 2001, which was driven to new heights by none other than speculative buyers hoping to make a quick buck. It seems when the prospects of making a quick buck are presented, that so many of us step outside our rational minds, and simply follow the herd to the edge of the cliff. This is exactly what happened to thousands when the tech bubble burst, many simply ran right off the cliff, and a few, while dangling from the cliff, were able in some way to salvage their portfolio before it was massacred.

We are now witnessing that same herd like behavior in real estate. The belief that real estate will forever go up at 10% to 20% per year seems to be permeating throughout society, and especially among Californians. While we agree that real estate is a great long-term investment, and over time you are certainly more likely to make money than lose money, we also caution that the herd tends to act irrational and can bring the market tumbling down.

Warren Buffett, the self-made billionaire investor and second richest person in the world sums up this situation best when he said,

“…Attempt to be fearful when others are greedy, and be greedy only when others are fearful.”

This philosophy drives a stake right into the heart of the herd like mentality of making a quick buck. When you see the herd running like mad and the picture looks all so rosy, and your thinking of joining…remember…DON’T. And on the other hand when you see opportunities in the market place, and others are fearful, and you begin to doubt yourself…remember…DON’T. Warren Buffett made his billions by spotting opportunities that others overlooked, not by following the herd to the edge of the cliff.

The following is a related story from CnnFn:

The California Effect