Tuesday, July 26, 2011

Housing price update

This first chart shows the latest data for two different but remarkably similar indices of home prices. The Case Shiller index tracks the sale price of the same houses over time, and reports the average price of homes sold, and the Radar Logic index tracks the average cost per square foot of homes sold. While both are showing that prices have slipped a bit in the past year, prices today (actually, the latest data report the average of the three months ended in May) are almost identical to what they where in the early part of 2009. Thus, we have had two years of relative price stability in the housing market. 

After adjusting for inflation, however, housing prices have fallen about 5% in the past two years. Real home prices are now about 39% below their 2006 peak. That's a significant price adjustment.

We can look at prices over a longer period thanks to the Case Shiller data which covers 10 major metropolitan areas (the top chart cover 20). This third chart is also adjusted for inflation.  
Those looking for further significant declines in housing prices might like this chart, since it suggests that prices could fall back to their 1997 lows, which would imply a 32% decline from today's levels. That would be painful indeed.

On the other hand, this chart of real median existing home prices shows that prices today are about the same as they were in the late 1970s, and that prices haven't even increased in real terms by 1% a year over the past 40 years. (It seems reasonable that real home prices should tend to increase by at least some small amount over time, to reflect rising real incomes and a rising standard of living).

In my opinion, what all these charts show is that there is good reason to think that the "bubble" in housing prices that formed in the mid-2000s has disappeared, and that prices today are reasonable, give or take a little, compared to long-term historical trends. There is no compelling historical reason, in other words, to think that prices need to drop significantly from current levels. Moreover, new home construction has been far below the rate of new housing formations for several years now, so we know that the excess inventory of homes has declined significantly. Whatever slack is left in the housing market could quickly become used up by a combination of 1) moderate economic growth, 2) rising incomes, 3) rising inflation, and 4) new household formations. And of course with mortgage rates near record lows, the effective cost of a home today is quite low by historical standards, perhaps as low as it's ever been.

I continue to believe that we've seen the worst of the housing market, and that the next shoe to drop will be the surprising news that prices are starting to rise and residential construction is starting to improve.


McKibbinUSA said...

Given the reality of declining housing prices, a declining employment to population ratio, the declining dollar, and rapidly increasing gold prices, I believe economists will now begin to conclude that the US is in depression, albeit limited in scope to Main Street USA -- the nation's "too big to fail" banks, the unionized automobile industry, Federal workers, and the defense establishment are being protected by fiscal and monetary policy in a misguided attempt to save Federalism from itself...

Frozen in the North said...

Unless something terrible happens you are probably right. What is also clear is that with the tremendous overhang of properties still out there, the ability of prices to rise again in the medium term (5 years) is seriously impaired.

An interesting statistics this morning on new homes, where 16% of all sales failed. According to experts more stringent mortgage requirements was the prime suspect for failure.

Benjamin Cole said...

I hope Scott Grannis is right with this well-done analysis.

On the other hand, house prices in Japan fell all through the 1990s, so that they could fall all the way through the 2000s also.

Sadly, we are following Japan's macro policies to a "T": We are running fiscal deficits, and we are trapped at zero bound.

Bernanke has backed off QE--just like the Bank of Japan.

If monkey see, monkey do, can we expect better than our furry friends at the Bank of Japan?

John said...

In the late 90s, my wife and I sold a house at a moderate loss. When I asked the real estate agent why the price didn't appreciate as RE agents said they did, he replied "houses IN THIS PRICE RANGE are not increasing in value.

Eureka! The housing market is not monolithic. Income distribution matters, and will be reflected in the housing market. High end and starter homes will hold value or increase. Middle class home prices will continue to fall.

Cabodog said...

Before anyone concludes that housing prices are stable or are continuing to drop, they need to interview someone who is actively looking to find a quality rental.

Rentals are high in demand and rental prices are increasing. Housing demand will soon be driven by fundamentals of the cost to rent vs. the cost to own.

This is a healthy development for the market and not based on speculation or greed, but based on the simple premise that people need a roof over their head and the cost of that roof is increasing, based on supply/demand.

septizoniom said...

mr grannis is in the denial stage still of tragedy. he can't accept that the fed cannot re inflate a bubble in an asset class that burned the common man.

Stone Glasgow said...

In housing markets that did not bubble, the cost of owning and renting a stand-alone home is almost exactly the same.

Why is there so much focus on calculating the likely future value of homes based on their historical value? The homes of today are rated to last much longer and are constructed with better materials, like plastic siding and high-stress concrete foundations.

A better way to value a home, in my opinion, would be to compare the cost of renting to the cost of owning. They should be roughly equivalent if all costs are considered. At a bare minimum we would see what the market expects future appreciation to be with this comparison.

Kurt said...

Indeed, there are some housing markets where the monthly cost to own (PITI) is significantly less than the cost of renting. The big hurdles for many prospective buyers are scraping together a down payment and meeting today's more stringent requirements to qualify for a mortgage.

Cabodog said...

As long as rents increase, home prices will increase. If renters can't get the down payment or qualify, investors will.

John said...

Cobodog is right. Finding a "quality rental" is like trying to find a "quality job."

Unknown said...

You're probably right, except a couple of points:

JOBS, JOBS, JOBS... Housing prices can stay stable or fall a little bit more. Interest rates can get close to zero. But if you don't have a job, you cannot pay your mortgage.

Also, the qualifications are harder today for a mortgage. That is why we see more cash purchases.

Even the 'guru' Suzie Orman did a flip flop and now said it's okay to rent. I know a lot of people renting who can afford to buy. The economy is too shaky for them to saddle up to debt whent hey have super clean personal balance sheets.