Was the Hamptons Property Bubble Speculative?

Richard Florida thinks the Hamptons property market is about to crash:

It's clear as a bell that the tremendous run-up in housing prices in places like the Hamptons, Miami, Naples, Florida, or other similar high-end vacation spots had little to do with demand. We're talking speculation pure and simple. My research on real estate prices shows that local wages make up about a fifth of local income in Naples, compared to around 90 percent in Silicon Valley. What drove prices in these markets was "outsiders," certainly - outsiders trying to make real killings on flips and speculation. With these speculative gains wiped out and virtually no mortgage market for high-end loans to speak of, real estate values in these places have a long, long way to fall.

I have a feeling that if he's right, he'll be right for the wrong reasons. Yes, property prices in the Hamptons might well fall. But the run-up in prices there wasn't speculative, and any fall in prices will also be based on fundamentals.

Florida's insight about the relation between real estate prices and local wages is an important one, but although it might be useful if you're looking at Miami condos, it's much less useful in the Hamptons, where locals haven't been price-setters for decades.

What drove up prices in the Hamptons was not speculators looking to "make real killings on flips". The Hamptons real-estate market might have been overheated in terms of price, but it was never very hot in terms of volume. Quite the opposite: the high prices were largely a function of the severe lack of supply in the market.

There's a difference between a speculative bubble and a virtuous cycle. In the former, people buy just because they think they'll make money by doing so, and I really don't think that was happening in the Hamptons. In the latter, a lot of rich and successful New Yorkers buy places in the Hamptons, making the area that much more desirable. That increases demand for houses, which increases the price of houses, which in turn makes the Hamptons seem even more exclusive and desired as a place to buy, and so on and so forth.

In such an atmosphere it's easy for social climbers to overstretch and to buy houses they can't afford. During the credit boom, no one noticed when that happened, because it was easy to borrow money to make your mortgage payments. Now, credit's much tighter, and those mortgage payments are being missed - hence the uptick in lis pendens proceedings which somehow managed to get splashed all over the front page of the NY Post.

The future direction of Hamptons property prices will be driven by exactly the same dynamic as that which drove the past direction of Hamptons property prices: the degree to which people want to buy homes there. Splashing out on a big Hamptons house is still a way of signalling to the world that you've arrived - John Paulson, who knows a thing or two about falling property markets, just bought a Southampton compound for $41.3 million.

And as Florida notes, the Hamptons houses in lis pendens aren't underwater: they're mostly listed for more than the amount outstanding on the mortgage. The Hamptons are like Manhattan: there are many more people who want to live there than there are places to live. That's what keeps prices at silly levels. If a few people end up having to sell their houses, there's no shortage of people lined up to take their place. The only question is the price those people are willing to pay. Yes, it might be lower than it was at the height of the boom. But the people who bought back then weren't looking to flip, they were just overstretching, in a very American manner.