From Robert Shiller in the NYT:
Home prices have been climbing. They have risen 27 percent nationally since 2012, even more in places like San Francisco. But why worry? If you accept the efficient markets theory — and believe that real estate is an efficient market — then these prices are based on “new information,” even if you don’t know what that information is.
The problem with this kind of thinking is that the efficient markets theory is at best a half-truth, as a voluminous literature on market anomalies shows. What’s more, even that half-truth is grounded mainly in the stock market, which attracts professional investors who sometimes do make the market behave efficiently.
The housing market is another matter. It is far less rational than even the often irrational stock market, for a couple of important reasons. First, most investors find it difficult to understand how housing supply responds to changes in demand. Only a small minority of people think carefully about such things. Second, it is very hard for the minority of smart-money investors who do understand such matters to bet against bubble-level prices in real estate markets. In housing, the smart money has relatively little voice.
Short-selling helps prevent bubbles from forming, but such negative bets cannot easily occur in the housing market. You can’t routinely borrow a house and sell it, promising to buy back the same house later to repay the loan.
Markets without the possibility of making these negative bets will be inefficient. That’s because if it is not possible to short, the smart money can do no more than avoid holding an overpriced asset. Canny traders are forced to sit on the sidelines, and watch in futility as prices decline as they expected. Without short-sellers, there is nothing to stop a group of ignorant investors — who get some ill-conceived idea that a certain investment is just terrific — from bidding up prices to extravagant levels. In the housing market, that poses an enormous problem.
During the financial crisis, some professional investors did manage to profit by correctly forecasting home price declines. They used mortgage derivatives such as collateralized debt obligations to place their bets. John Paulson of Paulson & Company is well known for very successfully profiting from his prediction of trouble in the housing market. But mortgages are not homes, and he and others like him did not beat down the emerging housing bubble before it grew out of proportion.
The bottom line is that there is no reason to assume that the real estate market is even close to efficient. You may want to buy a house if you love it and can afford it. But remember that you cannot safely rely on “comparable sales” to judge that the price is fair. The market isn’t efficient enough for that.