Affordability is the ultimate limit of any asset bubble. If prices are so high that no buyer can afford them, there are no transactions and thereby no market. The fear of many buyers in a financial mania is that prices will remain elevated to the absolute limit of affordability permanently. People who have this fear will put every available resource into getting a house before this happens. This becomes a self-fulfilling prophecy as prices get bid higher and higher by fearful buyers.

If prices were to remain at the upper limit of affordability for a long period of time, the rate of price increase would slow dramatically until it only matched the rate of wage growth and inflation because prices could only rise if people had income gains they could use to bid prices up further. If the rate of house appreciation slows down to where it only matches inflation, it fails to have significant investment value. Money would generate much greater returns if invested in other asset classes.

During the Great Housing Bubble, certain of the most inflated markets saw prices more than double their rental equivalent value. This significant additional monthly cost provides an economic return while prices are increasing rapidly, but once the rate of price increase slows, the additional “investment” is not providing sufficient returns to justify the use of capital. If price increases do not provide an investment return, many who bought in anticipation of that investment return will decide to sell the asset in order to put their money toward more productive uses. This selling slows the rate of appreciation even further. Also, if prices are not rising in excess of inflation, there is little financial incentive to buy because when affordability is very low, it is much less expensive to rent.

If there is no financial incentive to pay more than the cost of rent, people stop buying. The additional selling pressure from those no longer obtaining a return on their investment combined with the diminished buying enthusiasm for the same reason plus the presence of a low-cost substitute (rental,) stops prices from rising and eventually causes a price decline. Once prices start declining, the incentives are even more negative, and prices fall back to levels where they are affordable again.

As prices begin to fall, lenders become more conservative. They do not loan large percentages of the value on a depreciating asset because they do not want to have the loan balance exceed the resale value of the house since the only assurance banks have for getting their money back is the collateral value.

Prior to the Great Housing Bubble, lenders demanded 20% down payments to give them a cushion if values declined and they limited debt-to-income ratios to 28% to make sure the borrowers could afford to pay them back. When house values start declining, lenders require more cushion to protect their investments. The demand from lenders for larger downpayments to protect themselves reduces the number of buyers in the market because less people meet the more stringent requirement. Fewer buyers causes even lower prices and a downward spiral of tightening credit. This continues unabated until 20% down payments are the norm, and debt-to-income ratios fall back to their historically “safe” levels for banks (28%).

The deflation of the housing bubble was all part of the credit cycle. Credit availability is the greatest and standards are the loosest at the end of the rally when prices reach the affordability limit. Once people begin to default on their loans, credit began to tighten, and the real estate bubble began to deflate. Prices will continue to fall until they are affordable.

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Are you young, single, and broke? Are you also dreaming of buying your first home, but feel overwhelmed financially? If you can’t face the mortgage payments alone, there is another option for you. A growing trend throughout North America is for friends or family members to purchase property together and become co-owners.

When you buy a home with a friend, you can either live together as roommates, or keep the property as an investment and rent it out. You also have a choice as to how you split up the equity—whether you keep things simple at 50/50 or one of you takes on more of the payments/ownership.

Real estate has always been one of the best ways to build equity and to stand on stronger financial footing. Every month that you pay rent, you’re putting money into other people’s pockets which could used instead for monthly mortgage payments. When you’re finished paying off the mortgage, you have a house that’s your own. At the end of a rental agreement, you walk away with nothing.

Co-owning has become a viable option in recent years, as people are waiting longer than ever to get married and have children. It makes sense to build up equity in the interim.

Buying a home with a friend also means that you share the down payment, monthly mortgage payments, and the costs of repairs and maintenance. Because you’ll be saving a great deal of money, you and your friend can shop around for a larger property, or find one in a nicer area than you’d otherwise be able to afford.

In addition, you get to share a home with someone you love and trust. No more lonely nights!

Co-owning definitely has its benefits, but like any partnership, there is room for conflict. Before you start looking for a house, you and your friend need to hammer out all the details and put them in writing. There is too much money at stake to keep things vague, so write everything down.

First, you need to come to an agreement about what kind of home you’re looking for, in what area, and what price range. Determine how long you’re both willing to search for a home, and how many homes you each need to see before you’ll be ready to make an offer.

Once you’ve found a place you both like, you need to hire a lawyer to draft up a legal document that’ll detail how the property is divided, what each party is responsible for in terms of household expenses, and what happens to the home if one of you dies. If your friend passes away, will their share of the house go to you or to their surviving family members?

You also need to decide what will happen to the home if one of you wants to sell before the other person’s ready. For instance, you could meet someone special and want to start a life with them. In this case, you’ll probably want to sell the house that you share with your friend, but your friend might not be ready.

There are also smaller details that need to be ironed out such as who gets the master bedroom, what decor will go where, or how you’ll divvy the grocery bills. These things may not seem important right now, but often it’s the small things that create the most tension in a co-habitation situation. By planning ahead for all scenarios, you’ll save yourselves a lot of grief—and potentially save your friendship if conflict arises.

If you plan smart and communicate well with each other, becoming co-owners of a property could be the best way to enter the real estate market for the first time. You’ll work together to build up your financial security, share the pride of home ownership, and have a great time doing it.

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