Tuesday, April 7, 2009

Home price update

We got back home from Argentina a little after noon today. We had left the hotel in Buenos Aires, the LoiSuites Recoleta (very nice), almost 24 hours earlier for the Ezeiza airport. I still have to post some pictures and more reflections on Argentina, but in the meantime the housing price issue has stirred some controversy.

I plugged in the Case Shiller data for January released a few days ago (bear in mind that the January data is actually the average of prices during Aug.-Nov. '08). I've posted this chart several times before, and each time I've tried to guess where the data were going over the next several months, in order to get an idea of where prices might actually be today. The red dotted line is my projection. What it means is that as of today, housing prices in the markets covered by this index, in real terms, have probably fallen about 40% from their highs. That's pretty significant, and especially so in the context of mortgage rates that now are as low as they have ever been in modern history. Just a quick glance at the chart tells you that this bubble has just about completely popped.

Prices might well fall further, but likely not everywhere. The big markets, that had the biggest price runups, have already had significant declines. Smaller markets (not included in the Case Shiller data, which cover only the top 20 markets) are likely to see prices drifting lower for awhile, but that's because they didn't rise nearly as much as the bigger, more liquid markets, and they haven't fallen much so far. All real estate is local as they say, so results may very well vary depending on where you live.

But broadly speaking, major markets have now experienced a fairly spectacular decline in price and an astounding improvement in housing affordability. This next chart has data through Feb. '09. Using today's prices and mortgage rates, the line would probably be "off the chart."

Predictions of continued major declines in home prices overlook two important things, in my view. For one, they assume that buyers will remain frozen like deer in the headlights given the drumbeat of negative news, increasing layoffs, and wealth losses. I think instead that people are already responding to what is essentially the biggest drop in home prices to ever happen in our lifetimes, and that is why the pace of home sales has picked up dramatically. Price declines like this can't go on much further, unless you believe that unemployment will quickly rise to 20-25% and the money supply will shrink as it did in the Depression. And that brings up the second factor the bears overlook, which is that the Fed has never ever before done so much to ensure that prices don't fall. Money is simply in abundant supply, and banks are still making plenty of loans.

I just keep thinking that we have seen the worst of the housing market by now, and astute buyers and investors should be looking to take advantage of these prices.


Mark A. Sadowski said...

Why did you start the graph of inflation adjusted housing prices with the year 2000? Between 1997 and 2000 real housing prices rose about 18% and were already one percent below their previous alltime peak (since 1890) in 1989. Isn't this just a little deceptive? Extend the graph to 1997 and you might think real national housing prices have a great deal more to fall (and they probably will).

Scott Grannis said...

Simple answer: that's as far back as the Case Shiller data go. I'm not trying to hide anything. Prices could theoretically fall a lot more, I would argue against that. But I think they have fallen enough to awaken animal instincts. And I think the availability of cheap money adds to the newfound attractiveness of prices to put a floor under prices.

Mark A. Sadowski said...

Scott, But it's not as far as the Shiller data goes. It goes as far back as 1890. If you have MS-Office you have access:


Scott Grannis said...

Thanks Mark, I was unaware of that. After some quick calculations, and assuming that the home price series going back to 1890 is comparable to the series in my chart (it probably says so in the book, but I haven't checked), then my estimate of the current value of the real home price index is about 120, give or take a little. That would make prices today a little (7%) higher than their average for the period 1950-2000. That adds up to one more reason for me to think that we've seen the worst of the real estate news. Prices are essentially back to "normal" levels, especially if we assume (as I do having looked at other housing price series) that real home values tend to rise at least a little bit over time. Considering that interest rates are down to incredibly low levels, you have to conclude that housing is a bargain from an historical perspective.

Mark A. Sadowski said...

I'm still stunned that anyone thinks the bubble prices of the 2000's were sustainable or will ever come back in the near future. While there may be localized cases of sustained housing price rises, on a broad national level I can think of none.

Three historical cases stand out in my mind. 1) Robert Shiller has collected a magnificent database of US real housing prices since 1890. There was a housing bubble that peaked in 1894. Between then and 1921 real housing prices declined by 45%. It was not until 1989, 95 years later that real housing prices surpassed that peak, and then they only stayed that high though 1990. In the most recent bubble housing prices started to rise in 1997, the year of the Taxpayer Relief Act that extended so much preferential tax treatments to first and (for the first time) to second homes. In 2006 real housing prices were double their national average from 1890 through 1997. They are still 37% above that average and so real national housing prices will have to fall nearly 30% from current levels to get back to their secular trend average. 2) Japan had a huge housing bubble that peaked in 1990. Since then the Japanese residential land value index has fallen every year and now is over 40% below its peak. No one realistically thinks the prices of the late 1980's and early 1990's will come back in our lifetimes. 3) Piet Eichholtz did a research study of real housing prices in Amsterdam from 1628-1973. Although there was significant deviations from trend there is one inescable conclusion concerning the real housing price trend in the Netherlands over that 350 year period: it is flat. Not only has housing tended not to appreciate over four centuries in the Netherlands but there was one period between 1734 and 1816 when real housing prices actually declined by about 80%. They never again attained the peak values set the 1730's.

The link to Eichholtz's paper is here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=5051 I think people need to review the history of housing prices here and abroad to disabuse themselves of the incredibly false notion that housing appreciates over time.