Tuesday, April 26, 2011
This chart shows two different measures of housing prices, as calculated by the folks at Case Shiller and Radar Logic. Both are showing some softness in pricing in recent months (but they both report prices 2-3 months after the fact), and this appears to be raising concerns in the market about whether housing is entering a new downturn. I'm not as worried about that as I am impressed by how similar the two indices are, by how relatively stable they have been for the past two years, and by the fact that both show the housing price bust to have been of roughly the same magnitude (Case Shiller -31%, Radar Logic -36%).
Let's stipulate, based on this information, that housing prices in major markets across the U.S. have fallen by one-third from the high they reached in 2006. In real terms, that works out to approximately a 40% decline, as shown in the next chart. Over the same period, disposable personal income has risen by about 15%, and 30-yr fixed mortgage rates have fallen from 6.5% to 4.8%. Do the math however you want, that adds up to a gigantic decline in the cost for the average family of buying a home (available measures of housing affordability show that homes have never been so cheap). Maybe housing prices are going to fall another 10%, who knows? But prices have already fallen by several orders of magnitude, and another 10% is not going to make much of a difference in the long run, especially if the Fed succeeds in reflating the economy. A sustained rise in inflation, coupled with what could easily be a housing shortage (given the extremely low level of new home construction relative to new housing formations) could translate into hefty gains for housing prices over the next 5-10 years.
This last chart compares the Case Shiller measure of home prices to Moody's Commercial Property Index. According to this latter measure, commercial real estate has suffered an even greater decline (-45%) than housing prices, with commercial property values having erased all the gains of the past decade. Maybe prices will slip a bit further before this is all over, but there's no denying that there has been a humongous price adjustment. Surely the lion's share of the downward price action is now water under the bridge.
What strikes me most about the action in the real estate market is that it is the opposite of the action in the gold and commodities market, yet real estate, gold, and commodities are all classic inflation hedges. If inflation is heating up and the Fed has trouble reining it in, I have to believe that a rising inflation tide would provide strong support for all tangible asset prices, especially real estate. Of all the things available to an investor who is worried about inflation, commercial real estate looks like the cheapest inflation hedge out there.
Full disclosure: I am long VNQ and a few miscellaneous REITs at the time of this writing.
Posted by Scott Grannis at 8:39 AM