That is, increases or decreases in prices are based upon expectations for the future, not necessarily on fundamental reasons like percentage of income devoted to mortgage, interest rates, scarcity of land. If people "think" that prices would go higher, that will justify paying more than the intrinsic value. The exact same can be the case when and if people "think" that real estate is not a good storage of value.
Think of the NASDAQ bubble and the justification for Amazon (AMZN) or Cisco (CSCO) at 3-4x current share prices. In hindsight we can see that prices were ahead of the fundamental reasons for owning those stocks. However, because enough people thought the price appreciation would continue, the price traded as high as it did. Reflexivity made the price the level that it traded.
This same process could be driving a portion of the Google (GOOG) or Apple (AAPL) price action after earnings. Or maybe the current reflexive state is a correct estimate of future returns.
The PIMCO piece points out that the same reflexive price action is even more the case with residential real estate. The small decline this summer could just be a short term break before prices keep moving higher for another 5 years. It could also be the start of people thinking that the real estate is no longer the safe and secure storage of value that once was thought.
Maybe the bull market of the last 4 months in stocks and bonds is the first wave of capital exiting the residential real estate and into other asset classes. We might need 20% returns in stocks for the second wave and third wave of dollars to come out of the housing market. Rental prices have spiked 20% in San Francisco in the last 12 months. This could show that the marginal buyer has lowered expectations of future valuation and might be the start of a shift in sentiment. I would argue that momentum has shifted for the long term and might not reverse for 4-5 years. Conversely, lots of residential properties are selling at current asking prices which argues that not everyone has given up on real estate as the best present day investment class.
Bottom line: Fundamental valuation is only a proxy. Keynes' famous quote, "Markets will remain irrational longer than you remain solvent" alludes to the large gyrations away from fundamentals. In the case of residential real estate, looking at what the masses are thinking could be more important than the fundamental direction of interest rates and income levels.
Eventually, we will likely gravitate back to a mortgages at less than 25% of income. However, it could be take years to shift what people think the return on investment of a house will be. As their return expectations shift, the valuation will move dramatically. Wage pressures could push affordability back in line, or home prices will come down. In the meantime, we just have to look to what the masses are thinking in terms of future return expectations.
