The thought that the housing market would have a long, flat bottom might be changing. Initial looks at a couple of markets around the country are transforming the theory: instead of an extended flatline in housing value appreciation due to little demand and rampant foreclosure, periods where values and demand both spike may be on the horizon, thereby creating cycles of volatility

For a while now, the common line of thinking has been that increased levels of negative equity (underwater mortgages) would result in a rise in inventory (i.e., the number of houses on the market), and at cheaper prices, too. Combined with a decreasing housing demand because of people unable to afford moving from their homes, the prediction has been of an extended, static bottom in the housing market

However, the Miami and Phoenix markets are revealing another, overlooked effect: that there would be a flood of cheap homes onto the market wasn’t a surprise. But what many analysts didn’t consider was that all the homeowners who cannot sell their homes are trapped in them. This has actually decreased the overall supply of homes coming into the market

That this was overlooked shouldn’t have been unexpected, though. It made sense – market experts simply thought that people who had attempted to sell during the recession but couldn’t would now be able to make up for the lack of demand. These so-called “sideline sellers” would be lured back into the market by increased home values

Alas, that may not be true. Many of these sideline sellers are currently underwater on their own mortgages and may not be able sell now, either. And this is causing acute shortages in housing inventory – supply – which is causing prices to fluctuate

Research from the past year shows an interesting relationship: when the percentage levels of negative equity in a given market rise, there has been a corresponding dip in inventory. The higher the rise in underwater mortgages, the larger the drop in supply of housing

Specific numbers from Phoenix bear this out. The number of homes in the bottom price range that were put on the market declined 66 percent while values increased nearly 2 percent. On the flip side, the number of homes in the top tier that entered the market halved (33 percent) - and so did the corresponding values (1 percent)

Two main reasons are given for this. One, home values in the lowest tier fell further from their peak levels, making them more affordable than homes in the middle and highest tiers, especially to first-time buyers. Two, the homes in this bottom range are now more attractive to investors who want to make the homes into rental properties

Thus, the new hypothesis. A limited supply of homes because of negative equity combined with strong demand from investors and first-time buyers might create cycles of volatility. Home values might spike due to the demand; however, this could actually moderate price appreciation because rising home values might release some underwater homeowners from their negative equity, creating a higher supply of homes onto the market.