Are house prices a self-fulfilling prophecy?

Possibly. But let's start from the beginning, which was neatly summarised in this New Zealand Herald article from a couple of weeks ago:

An economist from one of New Zealand's biggest banks has questioned the role of the media in reporting on Auckland's housing market, asking if significant coverage of Auckland house price declines could be "a self-fulfilling" prophecy.

BNZ senior economist Craig Ebert was writing ahead of tomorrow's release of Real Estate Institute data for June and posed a question about the effect of the media's role in the market.

He referred to other recent data that showed prices dropping in some Auckland areas.

"The recent decline in Auckland house prices is now getting significant media coverage. This can be self-fulfilling to the extent that folk fearful that a market might correct are more likely to withdraw from it - buyers that is - and sellers will either delist their properties, simply not sell or, if under pressure, accept lower prices than might otherwise be the case," Ebert wrote.

One of the factors that affects the current demand in a market is expectations about future prices, which may be affected by media coverage. If a consumer (in this case, a home buyer) believes that the price of a good (in this case, a house) will be lower in the future, then they may hold off on purchasing now and wait for the lower future price. This lowers current demand for the good (houses). As shown in the diagram below, demand falls from D0 to D1, and the effect of that is that the equilibrium price falls from P0 to P1 (and the quantity of houses traded falls from Q0 to Q1). So the price falls, which is exactly what the consumer expected. Hence, this becomes a self-fulfilling prophecy.

But wait, there's more. If potential sellers expect prices to fall in the future, they may choose to sell their houses now, which increases the current supply of houses. As shown in the diagram below, this combination of decreased demand (from D0 to D1) and increased supply (from S0 to S2) leads to an even greater drop in prices, to P2. Note that the change in quantity becomes ambiguous - quantity of houses traded could increase (if the increase in supply is greater than the decrease in demand), decrease (if the increase in supply is less than the decrease in demand), or least likely of all the quantity could stay the same (if the increase in supply exactly offsets the decrease in demand).

But maybe sellers aren't that dumb - maybe they recognise that they can hold onto their houses for now instead (and rent them out), and then sell them at some point in the future once prices have recovered. In this case, the supply of houses for sale would decrease rather than increase. As shown in the diagram below, this combination of decreased demand (from D0 to D1) and decreased supply (from S0 to S3) leads to a certain decrease in quantity (to Q3), but an ambiguous change in prices. House prices could increase (if the decrease in supply is greater than the decrease in demand), decrease (if the decrease in supply is less than the decrease in demand), or least likely of all the price could stay the same (if the decrease in supply exactly offsets the decrease in demand).

So, are house prices a self-fulfilling prophecy? It really depends on the reaction of sellers. If sellers choose to cash out before prices start to fall (which I would suggest is probably the case for short-term speculators) then yes. However, if sellers choose to hold onto houses and wait out the downturn (which is more likely the case for owner-occupiers, landlords and long-term investors), then possibly not. At that point, it becomes an empirical question - if the quantity of houses changing hands falls significantly and house prices hold up, then the latter of those two explanations is probably having the greater effect.