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Was there a Housing Bubble?
The conventional wisdom is that there was a housing bubble which has now popped. The data, however, tell a different story. Remember, that the evidence for the bubble was that real house prices had increased tremendously since around 1997 leading to prices that were far above any seen in the past one hundred years. Here's Robert Shiller's famous chart.
The clear implication of the chart is that normal prices are around an index value of 110, the value that reigned for nearly fifty years (circa 1950-1997). So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices.
But what has actually happened? House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average (see chart in the extension). Since the peak in the second quarter of 2006 prices have dropped by about 5% at the national level (third quarter 2007). Prices have fallen more in the hottest markets but the run-up was much larger in those markets as well.
Prices will probably drop some more but personally I don't expect to ever again see index values around 110. Do you? If we don't see the massive drop back to "normal" levels then the run up in prices should be described as a shift to a new equilibrium - much as happened during World War II - see the chart. (It's an important question to ask what changed and why?). In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.
Here's a nice picture from The Mess that Greenspan Made.
Posted by Alex Tabarrok on February 13, 2008 at 07:45 AM in Economics | Permalink
Comments
Save this post, so that you can look back on it in later years. It's a bold prediction to make right now...hope you're right!
Posted by: Kevin Miller at Feb 13, 2008 8:14:47 AM
I think the tough thing about the housing market is that it moves much more slowly than other markets (such as stocks), so it takes longer to see. If the tech stocks were soap bubbles that could pop very quickly, housing could be more like a lava bubble that takes more time. That isn't to say that housing hasn't reached a new equilibrium, only that with the size of the investment for most people, I don't think you could expect to see a sudden drop as you do in other markets. People don't sell their house only because they don't want to lose any more money in their investment, unless they're speculators. Most people get value from living in the house they chose. The long term question, I think, is whether or not people who don't currently own houses can afford them, and if there is enough incentive for home builders to lower prices of new buildings. I believe your equilibrium theory holds if new homes are priced at current levels, and the market continues to buy them.
Posted by: Aaron at Feb 13, 2008 8:20:59 AM
I don't think I know enough economics to have an opinion on this, but I have a couple questions for those that do:
1. many people seem to expect above-trend inflation over the next 5-10 years; how would this change the visual effect here? I assume it would compress the whole graph vertically, but would it have a disproportionate effect on later/earlier periods? For example, I'm trying to picture (and can't) what this graph would have looked like in 1970, shown in 1970 dollars instead of today's dollars. Would that postwar spike have seemed even more prominent?
2. i think i have a general understanding of hedonic effects, and some differences between a "standard" house today and at the beginning of the graph are obvious -- but it seems like the average American house has gotten nicer (better appointed but especially bigger) much faster than the standard of living has risen over the last ten years or so. If this is true and it's part of what was going on in the "bubble," what does it say about that graph? For example, should we be drawing it on a per-square-foot basis like we would for commercial real estate?
Posted by: Peter at Feb 13, 2008 8:26:20 AM
I don't think I know enough economics to have an opinion on this, but I have a couple questions for those that do:
1. many people seem to expect above-trend inflation over the next 5-10 years; how would this change the visual effect here? I assume it would compress the whole graph vertically, but would it have a disproportionate effect on later/earlier periods? For example, I'm trying to picture (and can't) what this graph would have looked like in 1970, shown in 1970 dollars instead of today's dollars. Would that postwar spike have seemed even more prominent?
2. i think i have a general understanding of hedonic effects, and some differences between a "standard" house today and at the beginning of the graph are obvious -- but it seems like the average American house has gotten nicer (better appointed but especially bigger) much faster than the standard of living has risen over the last ten years or so. If this is true and it's part of what was going on in the "bubble," what does it say about that graph? For example, should we be drawing it on a per-square-foot basis like we would for commercial real estate?
Posted by: Peter at Feb 13, 2008 8:27:35 AM
Was the WWII up-swing a shift to a new equilibrium, or a shift back to the pre-WWI equilibrium?
Take a look at the last 10 years of the NASDAQ as a reminder of how far things can fall.
Posted by: Winslow Theramin at Feb 13, 2008 8:31:22 AM
This seems an odd time to make this argument. If it drops back to 130, was it a bubble? I'd say so. In my judgement, real housing prices could drop 30% from the peak, which would be about 130. Just looking at the top graph, it looks like that last peak to trough took about 7 years, so I wouldn't be bringing this up until maybe 2014.
Posted by: matt wilbert at Feb 13, 2008 8:32:29 AM
"Prices will probably drop some more" way to step out on a limb here.
I fail to see a connection between any evidence you’ve presented and your claim ‘there was no housing bubble’. So prices will ‘probably drop’ while there absolutely was ‘no housing bubble’.
Correction from a bubble this severe is certain to be measured in years. What sort of further price depreciation are you forecasting that you can make such a claim and what are your assumptions? All I see is a graph showing history of a correction well underway.
Of course, what do I know? I’m just a Credit Snob who thought that tighter regulation was the answer.
Posted by: Mark at Feb 13, 2008 8:54:36 AM
I have to agree with some of the other commenters. Whether or not housing has reached a new equilibrium, it is a stretch to say that equilibrium will be high enough to credibly claim there was no bubble.
Is it also your position that lending to people at 13 or 14 times income was responsible behaviour too? I don't mean to be pointed but this really does put you out there. I suppose someone needs to be the anti-Roubini - though his predictions are looking pretty good lately.
Posted by: Finnsense at Feb 13, 2008 9:03:02 AM
It has all the signs of a bubble. There is significant inventory overhang, including new homes, resales, and just coming on line, repos or bank REO. Numbers of sales are declining. People in non bubble areas are keeping homes off the market unless they are forced to sell, creating a hidden inventory. Ratios of prices to income are at record high levels. It is significantly cheaper to rent to buy in bubble markets. Yes it's now conventional wisdom, but if you want to question it, some serious data would help. There is all the evidence you could want plus more at the blog calculated risk.
We won't be out of this until residential housing no longer seems like an 'investment' -- let alone a good investment. I would say right now, most people feel like houses will be nominally more expensive in 5 years then today. Until people think of a mortgage as an anchor and houses as consumption, we won't be out of it.
Posted by: Ziggurat at Feb 13, 2008 9:16:09 AM
Isn't it too early to say what's going on here? The index shows a decline - at least, the one that Schiller showed at the AEA seminar in New Orleans a month ago did. In that series, which had new monthly data included that I think was an update of the chart from his second edition book, there was a fairly significant downward movement in the price index.
Posted by: jason voorhees at Feb 13, 2008 9:49:18 AM
I think that country and local government slow growth policies and other regulations play a role in keeping supply down which can cause a price spike if interest rates fall.
Posted by: Floccina at Feb 13, 2008 9:50:02 AM
You're not really presenting an argument here, other than "personally I don't expect to ever again see index values around 110", which is simply your own intuition. Other than that, you simply point out that the bubble hasn't fully popped yet, but in housing it's normal to take years for prices to adjust.
Posted by: at Feb 13, 2008 10:00:03 AM
I think the run up was caused by a combination of low interest rates and tax law changes enabling people to move without worrying about capital gains.
I also agree with the commenter that the lack of liquidity in the housing market causes it to take a long time to adjust to new prices. This would process will quicken if we get higher interest rates.
Posted by: Jeff at Feb 13, 2008 10:06:50 AM
I think the biggest problem with Shiller's chart is that it's not adjusted for interest rates. Make that adjustment and the recent run-up, while still apparent, isn't nearly as sever.
But I too was hoping to see some argument from Alex as to why there was no bubble. Instead, all I got was a flat assertion, with no supporting argument. Help us out here?
Posted by: David in VA at Feb 13, 2008 10:10:52 AM
Alex, how much do you stand to make on the bets you placed on the prediction markets that housing prices won't go down much more, since you seem pretty confident of that?
Posted by: Cliff at Feb 13, 2008 10:22:27 AM
The second graph says that prices have increased in cities which are more attractive for tourists or retirees (Miami is on top. Detroit at the bottom).
This makes me think that part of the story might be that housing prices reacted to a large shift in demand (inflated by loose monetary policy), while supply couldn't increase as fast.
Also, low interest rates and massive investment in US government bonds from foreign governments may have changed the asset allocation of many investors: real estate is often considered as an asset riskier than t-bonds but less than stocks. If t-bonds pay too low yields, and stock markets go down, it is not absurd to imagine that a lot of investments in 2001-2002 went into real estates. And houses do not pop-up in a couple of days. Again, this would lead to a shift in demand (obviously, more attractive cities would attract more capital, and this would explain the situation depicted in the second graph), while supply could not adapt immediately to the new situation (Rome wasn't built in a day... nor Miami beach).
What next? Probably we now have an increase in supply, and a partial decrease in demand. Prices might stay up or go well down, but the entire story might be that of a perfectly rational situation, not necessarily the boom and bust of a housing bubble.
Posted by: Roberto at Feb 13, 2008 10:25:00 AM
That new homes are getting larger may be true in some parts of the country, but definitely not here in New York City, and presumably in similar congested urban areas. You are definitely getting less square foot per dollar for new homes in New York.
Posted by: bronxilla at Feb 13, 2008 10:27:01 AM
So let me get this straight, everytime an asset price drops in value over a year or so, there has been a bubble? Geez, there must be a few hundred bubbles going at any given time.
Posted by: cb at Feb 13, 2008 10:27:58 AM
Shiller did a good job catching the housing bubble before it popped, and explained it at length in the early editions of his book "Irrational Exuberance."
I think the main problem with your chart though is that certain things become more meaningful when adjusted for "inflation" and some less so. We know those "constant dollars" (a) have less meaning when comparing a horse-and-buggy economy to a modern one, and (b) are recursive (when inflation is housing and housing is inflation)
A better bet would be for you to chart median home prices against median income. That's an easy way to separate the inflation issue (it should apply equally to wages and housing).
So how have median homes fared against median income in the last 100 years?
(Not the "mea culpa on debt" I was looking for :-)
Posted by: odograph at Feb 13, 2008 10:31:13 AM
P.S. - If you do the income/house-price chart it might be interesting to see percentage home ownership on the same timescale. It was generally considered a good thing when the post-war boom (and low prices?) led to an ownership boom.
P.P.S. - How many libertarian and free marketers are with me on eliminating the federal deduction on house interest?
Posted by: odograph at Feb 13, 2008 10:35:59 AM
In order to maintain those higher values, it would mean a sectoral shift in demand, whereas a bubble would imply a temporary increase in quantity demanded.
The best I can reason is that:
1. The dropping of mortgage interest rates led to permanent decreased cost of ownership, shifting a great number of those who were on the bubble of renting to home buying. While a small number of those first-time buyers used ARM's and over-purchased, many others took advantage of low fixed-rate mortgages. This would shift demand permanently instead of just moving along the curve, raising prices.
2. The above phenomenon also created a bubble in addition to the long-term change, allowing people who already owned homes to relocate cheaply. Some buyers may have even moved more than once, driving up prices in the short term. Since the market has cooled, they will not settle, so this should lower prices.
3. Interest free mortgages and increasing prices led to increased investment in the housing market, which would only have a short-term increase in prices. As the market has cooled, investment has shifted away from the housing market, which should also lower prices.
But that last chart pretty clearly indicates that there WAS a bubble. The data ends in 2006, and in 2007 we see a decrease in prices. While these prices are slow to fall, I believe they will slowly drop until they catch back up with the inflation rate or another mortgage phenomenon takes place (mainly because housing is not just an investment but also a useful and necessary good).
Posted by: J at Feb 13, 2008 10:38:08 AM
Odograph said:
P.P.S. - How many libertarian and free marketers are with me on eliminating the federal deduction on house interest?
---------
I wish someone could've nipped this in the bud before it became a politically untouchable topic.
What we should be doing is making college-tuition & education expenses fully deductible. There's a lot more evidence of the positive effects of education for a society than home ownership.
Posted by: Finance Monk at Feb 13, 2008 10:40:49 AM
I agree with Floccina. The metro areas with the largest run-ups are the ones where local governments restricted supply. Randall O'Toole's Thoreau Institute blog explained three years ago how smart growth was fueling housing bubbles.
Smart Growth and Housing Bubbles
Dallas, Houston, and Atlanta - three relatively unregulated metro areas - have not experienced the housing bubble, despite growing the most in population during this new century.
Here's another passage from a more recent Randall O'Toole essay:
"While housing prices grew by more than 130 percent in California and Florida from 2000 to 2006, prices in Texas grew by only 30 percent. With few exceptions, the states that saw the biggest bubbles were ones that had passed growth-management planning laws. And with one exception, every state that has passed such a law also saw a housing bubble."
Posted by: John Dewey at Feb 13, 2008 10:41:12 AM
You know John Dewey, what they call the "zoning zone" often corresponds to areas hemmed in by geography. Here in OC there is zoning (though it varies greatly by city). The bigger factor is that flatlands "this side of the mountains" are mostly built, and the commute-paths through the passes are bottlenecked.
You can blame it on the zoning, or the course of history that makes your other choice a 2-hour commute.
I assume that the cities with low prices have open geography and relatively fast commutes down-town?
Posted by: odograph at Feb 13, 2008 10:47:27 AM
Don't forget to adjust the lower graph for inflation, those drops from mid 06-07 would probably be 10-15 index points after taking 4% more for inflation (that would bring real prices back down pretty quickly).
I'd argue that there is some real adjustment in home prices necessary post 1997, to account for the capital gains exemption in home prices, but I don't think it's 100%.
I do expect that we'll see values in the low 100s (110-130) with a likely overshoot for a few years, too. But I'd guess that inflation will be more of a factor than nominal declines.
Posted by: nelsonal at Feb 13, 2008 10:56:43 AM
It may be correct to say that the bubble wasn't as large or widespread as believed, but it seems to me that there's been enough overshoot and decline to qualify as a bubble.
And I think it'll be interesting to see what happens going forward in the sense of the ability to pay for housing will interact with the willingness to pay. What I mean is that even mortgage payment levels that people can afford to pay without going bankrupt, there's still a problem in that previously, with appreciation, a mortgage was both a house payment and a savings plan. But if the expectation is for flat or declining prices over a number of years, then the savings plan component disappears -- in fact, the actual cost of ownership may be higher than the monthly payments, and it's possible that home ownership will come to be viewed as a financially foolish option -- which would have the effect of depressing prices even further.
Posted by: Slocum at Feb 13, 2008 10:58:27 AM
Odograph:
Less restricted building in areas like the OC or NYC would involve larger and more plentiful vertical buildings. Look at Hong Kong for an example of how to pack housing units into a small area.
Posted by: Houser at Feb 13, 2008 11:01:37 AM
Addendum:
WikiImage of Hong Kong housing. This is what unregulated housing looks like in a geographically restricted area:
http://upload.wikimedia.org/wikipedia/en/7/7d/Hongkongpeak.JPG
Compare with WikiImage of Orange County housing, where regulation is more stringent and anti-growth:
http://en.wikipedia.org/wiki/Image:IMG_0525small.JPG
Posted by: Houser at Feb 13, 2008 11:04:26 AM
Ziggurat is right - there has been a massive increase in homeownership that is tough to justify with demographics alone, the rent/buy price ratio is completely nuts at the moment, etc. If you want to claim this isn't a bubble, look at the pattern of house prices in true bubble markets like early 1990s HK and Japan. Housing prices didn't drop 50% (as they would eventually do) overnight because, for reasons mentioned above, there is some downward price stickiness in housing.
Look at some of the most expensive markets, where the median household can afford 5-10% of the houses on the market. What would make you think this is sustainable? At some point, budget constraints bind.
Posted by: cure at Feb 13, 2008 11:09:01 AM
A better comparison would not be the price of the home, but the monthly payment. Most of the population pays monthly, and that is what is considered when buy.
Posted by: Tom at Feb 13, 2008 11:30:00 AM
Houser .. OC did indeed "go vertical" in a big way last year. Unfortunately it coincided with a bubble ..
first high-rise foreclosure makes news
Posted by: odograph at Feb 13, 2008 11:36:53 AM
The similar bubble - or new equilibrium - in London might be partly explained by a change in funding. Young people not only get a mortgage but borrow from the Bank of Mum and Dad, which in turn produces the capital by remortgaging the parental home.
Posted by: dearieme at Feb 13, 2008 11:43:26 AM
All the evidence I've seen suggests that the price elasticity of supply of housing is huge--estimates seem to range between about 3 and about 10. This suggests that a permanent increase in the price of housing will lead to a massive increase in homebuilding. And, indeed, the extraordinary expansion of activity in residential construction from 2000 to 2005 supports this hypothesis. I think housing prices will fall, albeit slowly, back to that trend level, precisely because of the supply response.
This will be less true in highly congested urban areas (midtown Manhattan, San Francisco, maybe some others), but where there's space, the new construction will pull things back.
Posted by: Donald A. Coffin at Feb 13, 2008 12:01:48 PM
Here's my theory...
The expansion of global trade unlocked a bunch of value - which ordinarily would have gone to the Chinese (through higher wages) and Americans (through lower prices). Thanks to China's monetary policy, their share of value came back to the US in the bond market, thereby depressing mortgage rates.
Americans responded by supersizing their homes.
Posted by: SkepMod at Feb 13, 2008 12:01:52 PM
All the evidence I've seen suggests that the price elasticity of supply of housing is huge--estimates seem to range between about 3 and about 10. This suggests that a permanent increase in the price of housing will lead to a massive increase in homebuilding. And, indeed, the extraordinary expansion of activity in residential construction from 2000 to 2005 supports this hypothesis. I think housing prices will fall, albeit slowly, back to that trend level, precisely because of the supply response.
This will be less true in highly congested urban areas (midtown Manhattan, San Francisco, maybe some others), but where there's space, the new construction will pull things back.
Posted by: Donald A. Coffin at Feb 13, 2008 12:08:12 PM
I believe the increased prices are a permanent fixture even if we're retreating some from overshooting the new index value. The reason is that financing innovations are permanent (unless Congress does something stupid) & have widely increased the buyers in the market.
Recall that people used to buy cars based on the purchase price (I can afford $10,000, so that's all I'll spend). Now cars all sold on the monthly cash flow hit, which increased affordability and a lot more cars are sold and leased. A lot more expensive cars too. The same financing innovation increased the amount of businesses that could buy capital assets, junk bonds increased the number of raiders who could buy whole companies, and financing and brokerage innovation increased the number of people who buy securities, etc. Each of those innovations also led to bubbles of a kind, but eventually settled into a new market with permanently increased number of buyers.
Perhaps the argument is inarticulate or lacks the requisite jargon, but history shows financing innovations can radically increase the amount of buyers and that won’t change in housing market. Buyers who don’t have 20% down, or buyers with inadequate income but potential for increasing income, etc are now permanent actors in this market. And good for them.
Posted by: guy in the veal calf office at Feb 13, 2008 12:18:53 PM
"Now cars all sold on the monthly cash flow hit, which increased affordability and a lot more cars are sold and leased."
I, the stubborn cash buyer, am not sure this is a good thing. It coincided with a collapse of personal savings. It's as if we (ooh, this is good) we live care-free in a welfare state. We don't need to worry about our own future or economic responsibility.
Because in the new capitalist welfare state they'll just zero out interest rates and make everyone good again.
Posted by: odograph at Feb 13, 2008 12:32:23 PM
BTW, from my OC high-rise story:
"Walter Hahn, a real estate economist in Irvine who has followed the project since its development, said he is not surprised about the foreclosure because builder Bosa Development did not prevent or cap sales to investors. Hahn said he believes many of the original buyers were speculators,who hoped to resell quickly."
Would Alex comment on the normal fraction of home buyers who are short-term speculators ("flip this house"), and how that might signal a bubble?
(The fact that flipping shows made television is enough to certify it for me. In fact, I boggle that people can see those cable shows and not see a bubble.)
Posted by: odograph at Feb 13, 2008 12:35:39 PM
I can set alex up with people who would be willing to do OTC swaps of any size on real estate prices.
It is very early to be making claims like this.
You can get better realtime data from the Radarlogic site.
Posted by: mickslam at Feb 13, 2008 12:55:40 PM
After the depression there was a major shift in the manner homes were financed.
Previously homes were bought on 5 year balloon mortgages that had to be refinanced every five years.Under this system homeownership was stable at around 40% from 1900 to 1940.
After the depression the standard mortgage shifted to the 30 year mortgage we are all familiar with and homeowners rose to the 60s range that prevailed for most of the post-WW II era. This is probably what facilitated the shift in home prices relative to family income that Alex observed after WW -II.
For home prices to shift to a new level relative to income as it did after WW II
it would seem that some new standard of mortgages rather then the old 30 year mortgage would have to emerge.
In Japan in their bubble they even developed multiple- generational mortgages.
So Alex if you are right that we have shifted to a new and higher level of home prices relative to income I suspect we will need a new type of standard mortgage to replace the old 30 year mortgage.
Alex, do you have any suggestion as to what characteristics the new standard mortgage would have to facilitate a new higher ration of home prices to incomes?
Posted by: spencer at Feb 13, 2008 1:02:55 PM
Alex - US housing prices became rich to incomes and rents, but the real bubble was a global bubble in credit. Credit expansion had very significant Cantillon effects, and the run-up in US home prices was just one manifestation of this. That supported domestic US consumption in the face of weak income growth and - given declining domestic manufacturing capacity - led to a current account deficit. Given currency pegs of Asia ex Japan and OPEC the counterpart of US current account was fast domestic monetary growth and accumulation by foreign official insitutions of US assets (particularly Treasuries).
Note that lower rates lead to a one-shot increase in desired housing stock and equilibrium prices. If entrepreneurial agents should mistake this one-time shock (adjustment to equilibrium being spread out over several periods) for change to ongoing flow then you will see a cluster of errors when the music stops...
Posted by: Hedgefundguy at Feb 13, 2008 1:21:21 PM
The first chart is "real," the second "nominal." Apples and oranges. All prices have to do is increase by less than inflation long enough and the first chart will fully revert, even if prices technically increase during that time. Of course, our desire for bigger houses than our parents had may lead to a higher plateau...but the current price/income mismatch is nuts.
Posted by: DB at Feb 13, 2008 1:38:29 PM
I am definitely going to print this one out and send it back to you in two years or so. I know you folks are constitutionally unable to grasp the scope of the collapse that is occurring all around us (I visit here to check my pessimism when it gets too deep). But, to say there was no housing bubble . . . zoiks . . . I do expect a regression to 110 or so.
Posted by: laughCat at Feb 13, 2008 1:45:52 PM
Anyone have good data on housing prics in Japan over the same period? Without looking it up, I'd be willing to bet that there was a regression to 50 year average after their real estate and stock bubbles deflated. Just don't think there's been a shift to a sustainable new equilibrium. Plus, what about all the downsizing, hospitalized and dying boomers whose properties will be coming on the market in the next 20 years?
Posted by: laughCat at Feb 13, 2008 1:53:56 PM
Aug 12 2005
Memo on the Margin
There is No Housing Bubble!!
Memo To: Website Fans, Browsers, Clients
From: Jude Wanniski
Re: Nothing to Worry About!!
http://www.wanniski.com/PrintPage.asp?TextID=4559
Posted by: russ at Feb 13, 2008 2:08:24 PM
Actually the 110 price ruled for 110 year with the exception of the WWI-WWII period (which is pretty anomalous. A combination of a 30% drop and flat prices for a few years could easily get us back to the 110 range. Housing prices were essentially flat after 1991, so the drop you see is entirely due to inflation pressures.
Just like you can tell it's a stock bubble when your barber is giving you stock advice and people are saying it will never come down, you saw the same thing happen in housing.
So besides your assertion, what support do you have for your claim? Schiller seems to have a data, expertise and accuracy to what happened recently to home prices advantage over you.
Also, what's to say that this new equilibrium is any more stable than the equilibrium at 80 in the World War era and that after a couple decades, there will be a massive collapse in prices?
Posted by: Mo at Feb 13, 2008 2:26:00 PM
Karl Smith asks whether it was a housing or credit bubble here, and explains the difference between the two.
Posted by: TGGP at Feb 13, 2008 2:28:17 PM
The main reason housing prices haven't fallen further is that sellers have preferred to sit with the inventory. There's a stickiness to housing that doesn't occur with a market like stocks.
Posted by: ZBicyclist at Feb 13, 2008 3:12:42 PM
I enjoy reading your blog but not for its entertainment value. Until now that is. The fact that you would allow yourself that last "in italics!" statement is nothing if not hilarious! Keep it up!
Posted by: BayAreaIdiot at Feb 13, 2008 3:45:51 PM
laughtCat:
The Economist hit the topic about Japan some time back. Thank goodness for wikipedia: http://en.wikipedia.org/wiki/Image:EconomistHomePrices20050615.jpg
I'd be more interested in seeing housing prices correlated with a real measure of inflation.
http://www.nowandfutures.com/cpi_lie.html
Posted by: nobodyspecial at Feb 13, 2008 4:00:45 PM
Let me guess... you bought a house in the last 4 years.
Posted by: Rory at Feb 13, 2008 4:11:36 PM
To modify a quote from the Credit Snobs debacle:
Krugman 1 Alex 0.
Posted by: Mark at Feb 13, 2008 4:24:56 PM
Housing derivatives markets that use the S&P/Case-Shiller Index and the radar Logic RPX Index are showing 25% declines in housing prices over the next five years. A 100% retracement is probably not going to happen, back to 1996 levels, but these derivatives are showing that big declines declines are in the offing.
http://housingderivatives.typepad.com/housing_derivatives/2008/02/index.html#entry-45576440
Posted by: Lintel at Feb 13, 2008 4:30:40 PM
I'm going to provide evidence for the idea that comments go down in value as time goes by with my reiteration of many people's views: come on, how can you make this kind of assertion with minimal data, relying on your intuition for support and completely ignoring the precedent of the Japanese market?
The main reason I'm commenting is to vent. Lame posts like this make me consider no longer reading Marginal Revolution.
Posted by: Greg at Feb 13, 2008 4:36:19 PM
I'm surprised nobody (from NYC at least) is mentioning this (taken from the case-shiller FAQ)
2. What types of homes are included in the index calculations?
To be eligible to be included in the indices, a house must be a single-family dwelling. Condominiums and co-ops are specifically excluded. Houses included in the indices must also have two or more recorded arms-length sale transactions. As a result, new construction is excluded.”
It is preposterous to use this metric to determine what is going on in big cities, specifically manhattan. They do not include co-ops and condos, so essentialy it does not include any manhattan real estate.
The lesson as always -- real estate is CASE (no pun intended) SPECIFIC and too hard to just say "oh the HOUSING MARKET is going up or down". The "HOUSING MARKET" doesn't really mean anything. Compare that to the "(stock) MARKET". That is a tradeable instrument. You can buy SPY or QQQQ and "get long or short the market". You cannot just "get long or short the stock market". (and yes i know there are derivatives on the case-shiller, but they don't trade and are a joke in the finance community).
Posted by: JB at Feb 13, 2008 4:43:30 PM
Not surprising, nor indicative (one way or the other) of a bubble -- see Genesove & Mayer
Posted by: Faisal N. Jawdat at Feb 13, 2008 5:16:29 PM
So - NO Bubble - this is just a correction? a shift to a new equilibrium?
Earlier this week...
Question for Treasury Secretary Paulson about the mortgage and credit mess:
Q for Paulson: Is the worst over?
Paulson: The worst is just beginning.
Posted by: JRip at Feb 13, 2008 5:19:10 PM
Housing markets are mostly local. And you did see a big run up in housing prices in areas where supply was limited. I don't know if we saw a run up in income in these areas. i.e. did more higher income (or higher income potential) people move into some already tight housing markets.
What will decide long term housing prices? Growth in population and growth in income. But that can be a local effect. Families moving from Los Angeles to Las Vegas, Buffalo to North Carolina, New York to Miami, Detroit to anywhere else may have little impact on the markets they are leaving but could strain markets where they are moving. For example, a family leaving Detroit probably does little to suppress the already awful market in Detroit but could make a shortage of housing in Chicago worse.
Underneath these currents is the fact that we are becoming an increasingly service dominated economy and high value jobs are concentrated in a few markets - at least currently.
So are we seeing a bubble in the twenty largest markets that distort national data? Depends. Can these markets continue to attract new residents (and retain old residents) and offer incomes that outpace other areas.
Think of an old mining town. When money was to be made people flood in and prices rise. The high prices lead to expansion of housing and services. The mine goes cold, most people leave unless they have other opportunities in the area.
People will pay higher then normal prices in one market, as long as their opportunities in other markets are limited.
Posted by: DanC at Feb 13, 2008 5:30:00 PM
If you are going to utilize Iacono's Case-Shiller chart, at least use an updated one. You are three months in arrears in the housing bust.
Posted by: marmico at Feb 13, 2008 8:04:39 PM
You make a claim that there was no housing bubble and then below it, post a chart showing a big bubble. In the Case-Shiller chart, house prices have more than doubled in a span of seven years. Inflation during this span was 20-25%. You could make an argument that house prices were extremely undervalued in year 2000 and are now more fairly valued, but you are not doing this.
You will come to appreciate the long slow nature of the real estate cycle when your house, even in nominal terms, is ten years from now worth less than it is today.
Posted by: Bodz at Feb 13, 2008 8:44:04 PM
This is an inane, evidence-free argument you are making, particularly at the very start of the bubble bursting. Over the last ten years, houses were being mortgaged with unprecedented loan-to-value and loan-to-income numbers, numbers that violated decades of banking experience. As the folks at Calculated Risk pointed out yesterday, you can easily create a affordable mortgage for 13x your income by using all of the high-risk options (ARM, IO, payment optional). But if you convert that fancy loan back to a vanilla 30y fixed, the payments are 84% of your gross take-home income.
People can't afford the new houses without using the new instruments (newly popular, anyway). The new instruments don't work without a continuous cycle of refinancing or actual sales. Homeowners are now boxed in by a harsh reality. Prices will drop massively, as they have already just started to do. The large inventory build-up already shows a mismatch between buyer and seller expectations.
Posted by: travis at Feb 13, 2008 8:53:22 PM
I wonder how many of you talking about a housing bubble think it's a good idea to put one month down payment on a negative amortization loan with an interest rate fixed for one year which can reset to any interest rate upon 30 days notice at the whim of the loan servicing company after that first year. Because that's what you get when you rent.
If you want to try to time the market, fine, maybe prices will keep going down. Maybe the rent vs. buy indifference curves of others don't value not having a landlord as highly as I and I can buy lower by waiting a few years. But when I calculate the net present value of the stream of payments I'd need to make to get an equivalent benefit while renting I'd say home prices are too low if anything.
(Yes, if I could find a landlord willing to give me a 5 or 10 year lease on a home which I could use pretty much without restriction, I'd reconsider, but what would the rent be on such a dwelling?)
Those of you claiming there's a housing bubble... Did you sell your home and start renting? That'd be the rational thing to do, right?
Posted by: Anthony at Feb 13, 2008 8:54:57 PM
Reply to Anthony:
A lot (maybe most) of the people getting foreclosed in California, Florida, and elsewhere are going to rent now at less than 50% of what they were paying for their house.
Posted by: Bodz at Feb 13, 2008 9:14:39 PM
Bodz, a lot are probably living with friends or family for a while and paying nothing. But they're not voluntarily choosing such a situation. Sure, you can pay 50% of what you'd pay for your nice four bedroom house in a nice neighborhood if you move into a crappy apartment in a bad neighborhood with leaks and bugs and noisy neighbors (and no pets allowed), but that's not comparing apples to apples.
That said, I wonder what the chart would look like for real rental costs over the same period. Is there a rent bubble as well?
Posted by: Anthony at Feb 13, 2008 9:50:16 PM
Anthony, please post some evidence or don't post at all. I have read countless threads examining the total costs of renting versus home ownership in various markets (YES taking into account obvious things like size) and renting (and investing the difference) usually comes out ahead, especially if you're not sure you will live in one place for ten years or more.
Posted by: Cliff at Feb 13, 2008 10:07:48 PM
And California is one of the markets with the largest disparities between the cost of renting and owning. I have no doubt you could rent THE SAME HOUSE for 50% of what you could own it for in some areas of California, and yes I know people doing this.
Posted by: Cliff at Feb 13, 2008 10:10:04 PM
A lot of the people getting foreclosed in the bubble areas of the country are choosing to voluntarily walk away from their house. In many instances they could rent the same exact house for less than 50% of what they were paying for it (mortgage, insurance, taxes, etc.) They did not mind this imbalance when they brought their house because they thought that their house would apreciate 20% a year forever. But now, that prices are falling, they want nothing to do with their house. There was an article in WSJ yesterday http://online.wsj.com/article_print/SB120276871472760255.html?ref=patrick.net
about how, even after falling somewhat, prices are still, by historical norms, wildly overpriced in California (by 40%).
If you bought a house anytime in the last three years and don't end up in foreclosure, you will enjoy your house but live like a miser for the next 10 years.
Posted by: Bodz at Feb 13, 2008 10:35:55 PM
I don't quite understand bubbble. this data set bothered me, since it seems to ignore cost/sq ft, cost/person differences, and most important, actual cost born. A house value isn't terribly pertinent when house costs are effectively priced in terms of monthly outlay.
So, to verify, I went to the census page, and grabbed a few years worth of housing costs to verify. Year over year, housing costs have remained at ~27.5 percent of income, and in general, have decreased since the 80's. I got 28.4% in 84, 27.9% in 92, and 27% in 2006 (I did all years, but it is a dull, barely varying graph).
Doesn't this change the picture? Otheriws,e these plots seem fairly meaningless to me. 'prices' went up because mortgage rates went down. Nothing more.
Posted by: Brennan at Feb 13, 2008 11:33:59 PM
Brennan -- is the set all owners? I expect so. Long time owners would benefit greatly from the decrease in mortgage values (assuming they refinance or otherwise get the benefit of lower rates.) New buyers (since, say, 03?) are spending much more than that on their mortgage. And yet prices are set in the margin, so the folly of the past few years makes the home values of long term owners go up while their payments go down. So that subset sees a decrease in that percentage, which is probably the bulk of the set, yet there is a significant proportion that is a huge outlier to that.
Add to that lines of credit and other debt that has been premised on rising home values and "the wealth effect" and I expect overall the debt service proportion of income has skyrocketed. It's housing, it's debt, it's lack of savings, it's falling nominal "wealth" for those that bought in the past 5 years. It's a shock of pretty significant proprtions, no matter what you call it.
Come to that, I'm not sure anyone has set the terms anyway, not least Alex. What's a "bubble"? What are we talking about? How significant does the downturn have to be to be a bubble that has popped? A 25% real loss in value -- after inflation, thats about, what 5% a year for 3-4 years? -- brings that index down to 150. Pretty steep looking decline, and that kind of loss in value is not that farfetched.
I think you'll be eating this post later, frankly.
Posted by: benny lava at Feb 14, 2008 12:37:21 AM
Brennan -- is the set all owners? I expect so. Long time owners would benefit greatly from the decrease in mortgage values (assuming they refinance or otherwise get the benefit of lower rates.) New buyers (since, say, 03?) are spending much more than that on their mortgage. And yet prices are set in the margin, so the folly of the past few years makes the home values of long term owners go up while their payments go down. So that subset sees a decrease in that percentage, which is probably the bulk of the set, yet there is a significant proportion that is a huge outlier to that.
Add to that lines of credit and other debt that has been premised on rising home values and "the wealth effect" and I expect overall the debt service proportion of income has skyrocketed. It's housing, it's debt, it's lack of savings, it's falling nominal "wealth" for those that bought in the past 5 years. It's a shock of pretty significant proprtions, no matter what you call it.
Come to that, I'm not sure anyone has set the terms anyway, not least Alex. What's a "bubble"? What are we talking about? How significant does the downturn have to be to be a bubble that has popped? A 25% real loss in value -- after inflation, thats about, what 5% a year for 3-4 years? -- brings that index down to 150. Pretty steep looking decline, and that kind of loss in value is not that farfetched.
I think you'll be eating this post later, frankly.
Posted by: benny lava at Feb 14, 2008 12:39:19 AM
I say that the price of detached houses will rise without end, a million, two million, ten million, until the day that people start building houses illegally on land for which no permission to subdivide has been given.
Government could create a sand shortage in the sahara. What we have now is a shortage of permission to subdivide, which shortage can never improve, can only get worse. So prices must rise, rise, rise and rise some more till people start defying zoning laws.
Posted by: James A. Donald at Feb 14, 2008 2:14:51 AM
Cliff, I'm assuming someone with excellent credit willing to own the home for at least ten if not twenty years (not necessarily live in it, but live in it, rent it, sell it to family, whatever), because that describes me. Transaction costs in selling a home are outrageous, and people who have to move around all the time are often better off renting, but I'm considering my situation. I live in Tampa, Florida (that's right, Florida, usually mentioned after California in the list of the biggest bubbles), and I don't itemize (my total tax is zero anyway), so I get no benefit from any deductions. However, I do get the earned income credit which I would be ineligible for if I made more than $1900 in investment income in any year, not to mention that my eligibility for the retirement savings credit would quickly dwindle away if my AGI went up very much. In some situations my marginal tax rate is probably over 100% (for instance if I earned $2000 in investment income I'd be excluded from EITC *and* have my retirement savings credit decimated), but let's say I pay 20% marginal tax on investment income. I already contribute the max to my retirement accounts so that's not an option. My credit union offers a HLPR loan which requires 3% down, has no PMI, and has a 4.875% fixed rate.
In my particular situation I borrowed $20K from my parents at 0% interest paid $500/month, took $5K of my own money, and borrowed the other $150K at 5.125% for a PITI of $1135. But that's too obviously unfair due to the heavily subsidized loan (which my parents wouldn't have given me had I told them I was investing it in the stock market). So let's say I got a 95% loan, with no PMI, at 5.125%. That'd increase my payments by $110, to about $1250/month.
Now, show me a four-bedroom house in Tampa (corner lot in a nice neighborhood with a backyard) with an option for a long-term lease that I can rent for enough less than that that I've saved up $175K after taxes after 30 years.
You've gotta do the numbers, Cliff, because I've done them extensively and I can't find anything remotely close to home ownership *unless* I assume falling home values during the period of ownership. And I don't think it's fair to assume falling home values when we're talking about the value of a home. When I calculate a fair market value of a dividend stock I assume a holding period of forever, because I assume the market is going to rationally value the stock at the point of sale. If that assumption fails and the market overvalues the stock, then I sell. If the assumption fails and the market undervalues the stock, then I don't sell. But what if I need to move for work reasons or whatever? Doesn't mean I have to sell. If the market is undervaluing the house when I need to move I can always rent it out.
In hindsight, maybe I'll be wrong. Maybe homes are currently undervalued but in a few years they'll be even more undervalued. I recently lamented to my wife about the fact that our home might fall tens of thousands of dollars over the next few years. She said yeah, but isn't it so much better than living in an apartment? I said yeah, but with $25,000 you can rent a really nice home for a couple years. But I'm not willing to try to time the market. Are you? Again, those of you claiming a housing bubble, have *you* sold your home and started renting. Not do you see others doing it, have *you* done it?
Posted by: Anthony at Feb 14, 2008 8:20:55 AM
"I have no doubt you could rent THE SAME HOUSE for 50% of what you could own it for in some areas of California, and yes I know people doing this." Not if you compare it to a negative amortization mortgage with no money down, which would be the equivalent of renting (rent payments go *up* over time, and you never build any equity renting).
Posted by: Anthony at Feb 14, 2008 9:59:49 AM
Well, if you actually save the 50% savings, yes, you do. Obviously if your rent payments are equivalent or less than the interest portion of the mortgage, ownership is no boon. Add to that savings on taxes and maintenance. NYT had a fun rent v. own calculator a while back, that was actually pretty thorough. In some situations -- ie where rents are lower than mortgage payments, even when factoring in inflating rent payments over time, renters can be better off than owners. Long term.
Posted by: benny lava at Feb 14, 2008 10:50:17 AM
Anthony, most normal people wouldn't be so radical as to actually sell their homes simply to book a profit. For most people it's a home first, and investment second. Factor in upheaval, transaction costs, moving costs, plus some risk that their market assessment may not pan out as they think. Part of the whole problem has been that home ownership has been this vehicle to rapid wealth, (and leverage for consumer debt), with many bad decisions made as a result. Your "sell and rent" is simply the flipside of that folly.
Posted by: benny lava at Feb 14, 2008 11:04:01 AM
Now you're double counting, benny. If you're going to count the 50% you put into a savings account as built up equity, then you don't get to say you're spending 50% as much. Your 50% is excessively low for 99% of the country if you're talking about a 30 year fixed rate mortgage with a reasonable rate anyway. Maybe it's valid in Los Angeles, but it's certainly not valid anywhere I've examined the numbers.
"Obviously if your rent payments are equivalent or less than the interest portion of the mortgage, ownership is no boon." Only if you have an infinite (or at least 100-year) lease with a guarantee your rent payments will never go up.
You talk about a rent vs. own calculator. I say show me the numbers. I presented numbers. I could get a 30-year mortgage on my home with $5000 down for a PITI of $1250/month. I'd have to pay probably $1500/month or so for an equivalent rental. So if the house is worth more or the same whenever I sell it, I come out ahead. Put in a reasonable investment rate (anything higher than 6% is unreasonable because you can use options and/or futures to borrow money with a lower implied interest rate than that), and make sure the time horizon is long enough (really it should be infinite because I always have the option of renting out the house instead of selling it).
"Anthony, most normal people wouldn't be so radical as to actually sell their homes simply to book a profit." If you believe there's a housing bubble, let's say that means house prices are going to come down 25%, you'd have to be a fool not to sell. Upheaval, transaction costs, moving costs, etc. aren't going to make up for the $50,000 you'll save (on a $200,000 home). The problem is, as you say, the "risk that their market assessment may not pan out as they think". Which means, you're not so sure there's a housing bubble after all.
Home prices may come down in the next few years. One reason is that we currently have a credit crunch where even creditworthy borrowers can't get the loans they should be able to qualify for. But once this credit crisis is over I think things are going to go back up again, as long as the government doesn't do something stupid like try to outlaw certain types of loans, anyway.
Posted by: Anthony at Feb 14, 2008 11:43:49 AM
Here's a Wall Street Journal article about the difficulty of even measuring house prices... it's tougher than you'd think, and the two major indexes measure in slightly different ways and come up with different results.
Posted by: at Feb 14, 2008 11:54:41 AM
Hedgefundguy,
Given that Asian currency regimes haven't changed and oil producing states are still accumulating $'s, what is it that has changed? The current re-pricing of risk has just shifted funds out of riskier products to less-risky, the funds still have to be deployed, and looking at exchange rates, it doesn't look like it's leaving dollars.
Posted by: cb at Feb 14, 2008 12:33:41 PM
According to Shiller, his index (which is inflation adjusted) went from 100 in 1890 to 199 in 2006. I calculate an annual increase of 0.6% per year. That seems very small given the incredible improvement in housing over that time (size, appliances and heating, cooling and electrical systems).
Posted by: Rich Berger at Feb 14, 2008 1:22:03 PM
"Now you're double counting, benny."
I'm countering the point that rent is money thrown away and you can't build equity by renting. Nonsense. Mortgage interest is money thrown away too. Rent money from the bank, rent space from a landlord. And historically you can do better with your savings in the market than by holding real estate.
Usually I'd agree with you that ownership is by far the most advantageous way to procure accomodation. But when mortgages outstrip rents, it's a different thing entirely. Your example doesn't fit -- which is perhaps why you're being aggressive about this -- your mortgage payment is less than an equivalent rent, so why trade? If rent for the same space was 1500, and the mortgage would be 2000? 2500? 3000? what would you do? This is what the bubble zones are like. But if you own a home worth 175k that would rent for 1500, well, the numbers are fine. Trouble is in a lot of markets homes that are worth double or triple that rent for that much. If you're currently the renter, why buy? My best bud rents for $1900 a home that's worth a million bucks or more. Why would you buy it?
"If you believe there's a housing bubble, let's say that means house prices are going to come down 25%, you'd have to be a fool not to sell. Upheaval, transaction costs, moving costs, etc. aren't going to make up for the $50,000 you'll save (on a $200,000 home)."
And I think you'd be a fool to give up your home for chump change like $50 grand.
"The problem is, as you say, the "risk that their market assessment may not pan out as they think". Which means, you're not so sure there's a housing bubble after all."
That's a pretty lame "gotcha". Of course there's risk. There's always risk, and markets are unpredictable. Who'd a thunk we'd be where we are now? My point was the unwinding could take years, even decades, it could stall, have false bottoms, little spurts of markets rising, who knows. Doesn't mean I'm "not so sure". I think it's highly probable, but I'd be a fool to say anything is a 100% certainty and predict a timetable. Hell, most professional economists seem to have missed this debacle.
Posted by: benny lava at Feb 14, 2008 2:06:33 PM
Alex,
What argument are making? This is just your hunch... I don't see a single analytical argument.
The housing decline is a slow process with heavy momentum... homebuilders (the professionals) started slashing prices this summer in fire sale activity... homeowners (the novice seller) is just now cracking under the tremendous psychological pressures coming from the housing-credit debacle and looming recession...
Prices will continue to decline for at least 5 years... where they end up we will have to wait to see but in all past housing downturns prices "over-corrected" as sellers seriously capitulated during the main price "free-fall" phase...
We are in the price "free-fall" phase now...
Posted by: SoldAtTheTop at Feb 14, 2008 2:11:18 PM
Could it be the rise of regulation:
http://seattletimes.nwsource.com/html/businesstechnology/2004181704_eicher14.html
Posted by: elambend at Feb 14, 2008 2:47:31 PM
"I'm countering the point that rent is money thrown away and you can't build equity by renting." Well, you *can't* build equity *by* renting, though you can build equity *while* renting. Is rent (and interest) money thrown away? I think that's a semantic argument, and not one that I raised (I never said rent was money thrown away).
"But if you own a home worth 175k that would rent for 1500, well, the numbers are fine. Trouble is in a lot of markets homes that are worth double or triple that rent for that much." I live in Tampa, Florida, which is on pretty much all the lists as an example of one of the most prominent places where there is/was a housing bubble. This same house sold in 2003 for $134,000. So if there isn't a housing bubble here, I have a hard time seeing where there is one. I hear Los Angeles is/was bad. But we're talking here about a national-wide bubble.
"And I think you'd be a fool to give up your home for chump change like $50 grand." If "$50 grand" is chump change to you, you probably live in a house worth more than $200K.
"My point was the unwinding could take years, even decades, it could stall, have false bottoms, little spurts of markets rising, who knows." That raises an interesting question. If nominal housing prices don't actually fall that much, but there's a real drop due to inflation, can you even call it a bubble? I'd say no, especially since the purchases of those homes were tied to incredibly low-interest-rate loans (and that's something we still have, the 10-year bond is at 3.81%). Without the house, you can't get the loan. That does seem somewhat unfair though, if the fear of a housing market collapse creates the fed moves which create the inflation.
Posted by: Anthony at Feb 14, 2008 2:50:20 PM
Anthony,
I am not doubting the numbers for your situation, although you do appear to have left out large and important costs of home ownership such as maintenance, insurance, and property taxes.
But I was not addressing your particular situation. Bodz said "A lot (maybe most) of the people getting foreclosed in California, Florida, and elsewhere are going to rent now at less than 50% of what they were paying for their house." and you replied that "Bodz, a lot are probably living with friends or family for a while and paying nothing. But they're not voluntarily choosing such a situation. Sure, you can pay 50% of what you'd pay for your nice four bedroom house in a nice neighborhood if you move into a crappy apartment in a bad neighborhood with leaks and bugs and noisy neighbors (and no pets allowed), but that's not comparing apples to apples."
This statement of yours is not correct. We are talking about people getting foreclosed on in bubble areas. You seem to be saying you are in the worst bubble area in the world but a 175k house that went up 40k in 4 years does not sound like the worst bubble area to me (~7% appreciation for 4 years). Even if you don't think so, trust me that there are many areas where rent payments are less than mortgage payments on the same house, and that is not including other costs of home ownership. In that case, you are better off renting and saving the difference and will end up with a higher net worth that way. And YES, I am renting.
Posted by: Cliff at Feb 14, 2008 3:13:11 PM
This analysis is about as lazy and superficial as something I'd find in a Google Finance forum. First, your data is old - the CS index recorded an 8.4% YoY real decline in Jan '08. But more importantly, you fail to even mention the presence of downward price stickiness that suggests sharp future declines (which anyone in the RE business will attest to), the unprecedented inventory glut and homeowner vacancy rate, wave of mortgage bank failures/mortgage derivative write downs, the sharp uptrend in delinquency rates, home starts, completions, and transactions diving off a cliff, and homebuilder confidence at historic lows... you know, all the things that serious analysts of the market tend to look at. Please do us a favor and educate yourself by reading Calculated Risk's Jan 08 Real Estate news letter, or more generally by occasionally reading the number of quality blogs that regularly cover the RE market. And before Marginal Risk feels inclined to opine on anything outside its normal purview, remember:
“Better to remain silent and be thought a fool than to speak out and remove all doubt.”
Posted by: Dave at Feb 14, 2008 3:44:28 PM
Sorry, that should read "Marginal Revolution feels inclined...".
Posted by: Dave at Feb 14, 2008 3:48:22 PM
Here is the NY Times rent vs own calculator:
http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html
Posted by: meter at Feb 14, 2008 4:21:46 PM
Cliff, I gave you PITI which includes insurance and property taxes. Yes, I left out maintenance costs, although I also left out renters insurance. I'm not sure maintenance costs are significant enough to make a difference, especially since home ownership allows you to choose things like buying a more energy efficient hot water heater and air conditioner, thereby bringing down your ongoing expenses. Most landlords won't go for that. But if you want to add them in for your net present value analysis feel free, so long as you add renters insurance.
"We are talking about people getting foreclosed on in bubble areas. You seem to be saying you are in the worst bubble area in the world but a 175k house that went up 40k in 4 years does not sound like the worst bubble area to me (~7% appreciation for 4 years)." I don't deny that there were bubbles in some areas. There have pretty much always been local bubbles. I just don't see a national bubble. And I don't claim to be in the worst bubble area in the world, but my city is usually listed in the top 10 or 20 purported bubble cities.
Anyway, Cliff, you asked me to provide evidence. I provided numbers from my own house which correspond fairly closely to numbers from my county. US-wide numbers are even flatter over the past 10 years, using Zillow as a guide. So I don't think there is or even was a national bubble. The NASDAQ went from 600 to 5000 in four years and then from 5000 to 2000 in a year. That was a bubble. The National Case-Shiller Index went from 107.90 to 189.93 in six years, and was at 180.45 20 months later. Sure, you can twist the numbers around using inflation-adjusted figures, but I'm sure that can be done for a large number of different markets which no one is calling a bubble.
"Even if you don't think so, trust me that there are many areas where rent payments are less than mortgage payments on the same house, and that is not including other costs of home ownership." Well, as I've said time and again, you can only compare rent payments to mortgage payments if you're talking about a negative amortization loan, because rent payments go up over time. If your no-down-payment mortgage payment (including insurance and taxes) is equal to what you'd pay in rent, then you're certainly going to come out ahead, because that payment never goes up and after a certain number of years it goes away completely. Depending on the level of inflation it can be perfectly rational to pay twice as much in monthly payments toward a 30-year mortgage vs. the equivalent starting rent.
"In that case, you are better off renting and saving the difference and will end up with a higher net worth that way. And YES, I am renting." I'm glad you're at least following your analysis of the situation. I'm following mine.
Posted by: Anthony at Feb 14, 2008 4:51:40 PM
Dave posted: you fail to even mention the presence of downward price stickiness that suggests sharp future declines (which anyone in the RE business will attest to)
Mumble Jumble. Dave, you don't know what price stickiness means, do you? Please do us a favor and educate yourself first.
Posted by: Bodz at Feb 14, 2008 5:17:23 PM
Dave, educate YOURSELF first instead of berating people much more intelligent than you.
Your rant was very unimpressive.
Posted by: Bodz at Feb 14, 2008 6:00:17 PM
I am old. When I was young and engaged in primal physical activity with females, it didn't occur to me that most of them didn't achieve "satisfaction." I was gifted with the ability to take as long or as little time as I wished. Unfortunately, I didn't know that it takes females, on average, a lot longer to "get there" than it does males. Hopefully the analogy is tactful enough; nevertheless I believe it apt: you have not given the market enough time to collapse, as it surely will. People will stretch to their last dollar/pound before giving up and waking away. It is coming. You finished early, as I did when I was young.
Posted by: Rick at Feb 14, 2008 8:15:51 PM
Price houses should reflect affordability of the working people. And they do not afford them because their income stays the same while house prices go high.
Over more banks do not have money because people cannot save nowadays any money. Banks have managed for a very short period of time to lend triple the money and making triple the money on paper but that is gone. No more unless they start printing money.
OK people could not afford but buy-to-let did, and with the bank money which is people’s money in the end. So the moment the loan was too high for normal people buy to let got the loan because bank argues repayment comes from the rent, this why higher offers for houses were coming from buy-to-let investors. If this process keeps on going ... 1000 people will own in the UK, half of the houses that will be rented to normal people who get rejected by banks nowadays. Credit scoring!
Great finance on paper! Enron type of business!
Posted by: Peter at Feb 14, 2008 8:23:18 PM
Anthony,
We have agreed that for those planning to live in a home for less than 10 years, renting is often better than buying. We have agreed that in some areas renting costs less, on an immediate monthly basis, than buying. Your argument appears to be that no one is better off renting than buying and living in a home for 20-30 years or more and because owning is cheaper than renting, there can be no bubble.
There are many problems with this argument. One is that it is based on the assumption that the price of owning a home has to be systematically overpriced compared to the price of renting for there to be a housing bubble, which is not obvious to me. Two is that it ignores the probably majority of people who can not reasonably plan to live in the same place for twenty years or more. A third is that you _can_ come out ahead by renting for 30 years or more.
I would say that the fact that housing prices in some areas appear to have priced in an expectation for large future price appreciation is an indication that there was a housing bubble. You can tell because the price of owning, without considering price appreciation, is higher than the price of renting for most people. Neither of us have the data to prove or disprove that point, but I think I can cast some pretty significant doubt on your conclusion that you will always or almost always come out ahead buying and "holding" for 30 years.
What you are ignoring in your calculation is that the difference between rent and housing costs now (including the down payment and closing costs!) can be saved and invested and may make up for any inflation in rent relative to the price of owning a home. Not having to make a down payment is a huge factor that often makes the difference. A down payment now is way more than the present value of not having to make payments 30 years from now, which is approximately zero (seriously). Clearly whether you come out ahead renting depends at least on the the relative costs now and the length you stay in one place. Rent will increase with inflation, but so will homeowner's insurance, maintenance, utilities. The fact that you discount maintenance tells me you have little experience in the matter. Replacing a roof, A/C, heating system etc. is expensive and those are all things you _will_ have to do if you keep the house 30 years as you propose.
Let me run some simple calculations to show you when you may come out ahead, even after 30 years. As an example, like you I will use my own area. My rent is $1160/mo. The cheapest comparable condo lists for $300k. Lets say you get it for 280, with a 20% down payment and 5.7% 30-year fixed. Down payment is $56k. Closing costs are $5k. Payment is $1300/mo. Condo fees are $200/mo, insurance $60/mo, utilities I don't pay for at my apartment and maintenance total $110/mo. So first year, annual cost for renting is $13920 and for owning is $20,040. After that, rent rises with inflation (4%) and non-mortgage payment owner costs rise with inflation (4%) while mortgage payment remains the same. Assume 6% real rate of return for a 10% discount rate. Around year 14 owning becomes cheaper. In total, the cost discounted to present value after 30 years of the monthly expenses is $228k for owning and $208k for renting. The house value rises with inflation (remember, no appreciation) and its present value at the end of 30 years is $52k. Add in closing costs and down payment and the total cost of owning is $237k, while the cost of renting was $208k.
All that ignores the many advantages of renting including low transaction costs that allow you to easily upgrade or downgrade or move as your circumstances change. Even if you play with the numbers quite a bit, renting is still better. Clearly there are many times when renting is superior.
Posted by: Cliff at Feb 14, 2008 10:21:18 PM
My calcs also depend on perfect credit for the owner, which most people don't have.
I ran your completely pie-in-the-sky numbers (+ $100/mo maintenance) and it shows you're saving yourself about $100k in present value by owning, so you made the right choice. But most people cannot get 95% loans with no PMI at 5% and most people would not have to pay $250/mo more to rent. Your locale and situation is very unique.
Posted by: Cliff at Feb 14, 2008 10:43:54 PM
What the hell?
This is an ARGUMENT? Where? I don't see one. I mean, seriously:
"Prices will probably drop some more but personally I don't expect to ever again see index values around 110. Do you?"
That's IT? That's your knock-down blow - an appeal to people's gut instinct intuition?!
As people have pointed out above, the post-WWII move is a return to the previous equilibrium level after 25 years of global strife, not a ratchet move to a new equilibrium.
This is a non-argument. There is nothing to see here.
Posted by: Kaitain at Feb 15, 2008 12:41:00 AM
Well it's an argument and frankly only time will tell whether or not you're right. However one factor I think you make rather light of is that there are two major shifts to a new trend level in housing; post WW1 and post WW2.
Now given that these are US figures one cannot argue that population drop resulted in excess supply and low prices in the way might have been able to argue that of France or Germany or Britain, all of which lost an appreicable proportion of their male populations aged 16-40. I'm not sufficiently au fait with the economic circumstances in the US that might have led to a repositioning. However I think you need to explain that fall. I do know for instance that WW1 fueled a sharp expansion in the US manufacturing base.
However the second shift coincides with the end of WW2. The Second World War was not just a major historical event but a major economic one with the war driving the US economy out of the depression that had struck post 1929. The relevelling of the index at that point must be linked to factors at that time - increased industrial output, returning military personnel expecting homes and homes being provided, increased immigration from a devastated Europe....
That brings us to the latest rise in prices - which haven't yet established a new base level. Personally I'd associate the expansion with a flood of cheap money,; easy credit and a vastly expanded money supply - M3 had been growing at a double digit rate against inflation rates of less that 5%. Nor does the CS index translate well to the UK for instance where previous spikes are smaller but still comprable to the present one. That it appears to be a spike is to some extent supported by similar spikes in other asset prices; art, and wine for instance. If there's a fundamengtal shift in the world economy at present it's related to the rapid growth of China and India and the shift of the center of gravity of the world economy to the Pacific. However I am unclear how this might boost general house prices in Eurpoe and the US.
In short you make an interesting point but by you make it before we've seen a new plateau emerge and without a strong supporting argument. There's no reason why you shouldn't be right but I'd like you to explain both why and why now?
Posted by: Jonathan at Feb 15, 2008 2:29:52 AM
"Assume 6% real rate of return for a 10% discount rate."
Absolutely not. I can borrow from my credit cards at less than 10%. I can buy options with implied interest rates at less than 10%. I can get a 125% home equity line of credit at less than 10%. I can borrow on margin at less than 10%.
As for your assertion that "most people cannot get 95% loans with no PMI at 5%", I'm not sure that's true - I believe most people, at least when not in a credit crunch environment, could get such loans, if only they looked for them. Certainly they could get an 80/15/5 with a rate on the home equity portion less than that 10% rate of return you claim. Speaking of which, is that before or after taxes?
"Your argument appears to be that no one is better off renting than buying and living in a home for 20-30 years or more and because owning is cheaper than renting, there can be no bubble." Not "living in a home", "owning a home". Otherwise, correct. You can't call it a bubble if the asset is undervalued.
Posted by: Anthony at Feb 15, 2008 10:32:10 AM
Bodz - price stickiness in the housing market, and the RE market more generally, is observed in the tendency of sales volumes to drop well before prices drop. This is because most people would rather take their house off the market than sell it for a lower than desired price. Of course, these days buyers are forced to unload their properties - in some metro areas for 20, 30% less than the purchase price- because they have to get out from their resetting mortgage. Buyers know this and will wait longer until sellers make more concessions. In the meantime, volume plummets until the new market clearing price is found.
Anything else you want to accuse me of not knowing? Is there anything about that that's mumble jumble?
You're right about Alex being smarter than me; I wouldn't even try to get a Ph.D in econ. But even very smart people can occasionally make very bad arguments (the great economist Irvin Fisher ruled out the possibility of a recession as late as the summer of 1929).
Posted by: Dave at Feb 15, 2008 10:33:50 AM
Anthony,
That is your only response? You are basing your entire argument on your certainty that stocks will produce significantly less than a 6% real return?
You really think it's so improbable that stocks will return slightly less than their historical average or better over 30 years and that destroys my argument? What discount rate are you using? My inflation rate estimate is very conservative.
As I said, you can change things around a lot without the results changing. How about 2% inflation and 8% discount rate? You really think stocks will return less than 8% over a 30 year period? It makes me laugh that you suggest houses are undervalued generally speaking. I want to hear what numbers you have to use to make it better in my scenario to buy and own. My guess is that they are far from accepted.
And we are talking about the most generous scenario for owning (owning your house forever) and ignoring the many benefits of renting and the people with less than perfect credit or who cannot expect to stay in the same place over thirty years.
As I said, I think I have cast significant doubt on your assertions.
Posted by: Cliff at Feb 15, 2008 12:15:42 PM
"You are basing your entire argument on your certainty that stocks will produce significantly less than a 6% real return?" No, I'm basing my entire argument on the fact that it's irrelevant whether or not stocks will produce less than a 6% real return. If you want to gamble on the stock market producing above average returns, you can do that *regardless* of whether or not you own a home. Like I said, you can take out a 125% HELOC and pay less in interest than that 6% real return. So if anything owning a home lets you invest *more* in the stock market than renting.
"How about 2% inflation and 8% discount rate?" 2% inflation is too low. Even the treasuries are implying 2.69% average inflation over the next 30 years, and personally I think that's low. I'd be happy with 4% inflation at least for rent, but to go lower I'd have to study it more. As for the 8% investment rate, I'll give it to you *if* you 1) treat that as a before tax rate and discount at least 20% for taxes and 2) you let me refinance my mortgage at optimal points whenever my LTV drops enough to justify refinancing. You have to allow me to tap into all that equity that's being built up 5, 10, 20 years down the road if you're going to set earnings on investments so much higher than mortgage rates.
Posted by: at Feb 15, 2008 12:59:09 PM
cb - "Given that Asian currency regimes haven't changed and oil producing states are still accumulating $'s, what is it that has changed?"
The Asian + OPEC currency regimes _have_ changed - at the margin they are buying fewer US Treasuries and more risky and non-dollar assets. The rise of the Sovereign Wealth Funds is just one expression of this change in reserve management policy. Unfortunately the US hasn't been all that welcoming to certain kinds of inflows. One impact of such a policy change is to increase term premium - the low levels of which (as measured by the 2s10s swap curve or the 2-10-30 butterfly) gave rise to the conundrum. (One may note with some amusement that the 'conundrum' gained its peak coverage just as it was going away).
What's really changed though is risk appetite and economic confidence. Why was it that in Feb 2007 all the investment bank economists and policymakers were congratulating themselves for having achieved that rarity - world firing on all cylinders? Not a cloud in the sky - yet a few months later the picture looked very different. Well economic confidence has by definition a non-rational component subject to ebbs and flows of its own. The human tendency to attribute a favourable run in economic outcomes to high quality economic and corporate management never ceases to amuse me.
By the way, economists are notoriously lousy macro forecasters at turning points (where the money is made!) and the thinking of great macro investors is rarely in line with conventional academic wisdom about macroeconomics. Wall Street collectively has never forecast a recession before it occurred. One is part of the crowd and therefore inescapably affected by mass psychology and irrational influences on confidence. Economists are as bad as anyone in attributing their own sense of confidence (or otherwise) to 'fundamentals'. To make money you have to see beyond that - anticipate shifts in confidence before/as they occur.
" The current re-pricing of risk has just shifted funds out of riskier products to less-risky, the funds still have to be deployed, and looking at exchange rates, it doesn't look like it's leaving dollars."
When assets are repriced in such a massive way, it's less about large selling by informed and savvy participants and more about an evolution in beliefs and swing in sentiment of the pool of existing and potential holders of the asset. There is just no bid for CDOs, so the perceived value was illusory - the existing funds aren't there to be reallocated to other products.
The dollar often does well in a recession - if consumption slows and the current account (flipside of net private and government dissaving) starts to improve this will reduce the need for capital inflows to fund the deficit. Investors have also set substantial strategic overweightings of international assets and an unwind of this will be dollar supportive. Bigger picture though, although a dollar bounce is possible, prospective likely scenarios for joint fiscal and monetary policy are very bearish for the dollar against real assets.
Posted by: Hedgefundguy at Feb 15, 2008 4:04:58 PM
Anthony,
Your whole first paragraph makes it seem like you don't understand what we are doing. We are comparing the difference between owning and renting. Clearly that requires a measurement of the opportunity cost of the large initial payments made in purchasing a home. It has nothing to do with gambling on above average returns. It has everything to do with properly discounting future savings compared to savings now. The discount rate is not "above average stock returns." In fact, I am being very conservative and estimating a 5% real return (now) over 30 years. Most people can expect to do better if history is any guide.
Owning a home will not let you invest more in the stock market because the initial down payment and initially higher monthly payments more than make up for the later ability to take out equity. It also would be pointless to take taxes into account because treatment of house sales and stock sales are essentially identical. Neither requires taxes to be paid until a sale is made. Although there is a mortgage exemption, after 30 years of inflation at 4% the value of the tax break will be low enough to be inconsequential. So each scenario is affected equally by taxes. (Also, trying to predict the tax code 30 years in the future is futile, but lets assume stasis)
This is the last math I'm going to do. Any more calcs you can figure out on your own spreadsheet and the readers of the comments can decide for themselves who is being more reasonable.
Adjusting the numbers to your desired 4% inflation and 9% return (5% real return... a very low number historically for a 30-year time period) you still come out ahead renting after 30 years. Now taking into account a person who takes out equity in their home and invests it becomes very complicated. If you want to delve into it further be my guest. But assuming that at 15 years you refinance to 80% of the home value and to keep it simple, maintain that level of debt the rest of the 30 years, that gains $12k in PV and loses $2k in present value on transaction costs. Now the two options are almost equal... after thirty years living in the same place... with only a 5% real return... with perfect credit... assuming interest rates never go up... basically living in a fantasy land... but renting is still ahead by about 1%, or $2000 in present value.
I believe there are many locations with similar numbers to this. If you are deciding whether to rent or own, my advice is to run the numbers yourself and not just accept dogma from anybody. If you are trying to figure out if there is a housing bubble, time will tell, but I do not think it is reasonable to say that housing in general is underpriced. I don't think the case has been made for that.
Posted by: Cliff at Feb 15, 2008 11:13:41 PM
Why should we ignore the cost of new construction when looking at housing prices? Isn't that the replacement cost for the existing housing stock? With building materials at record highs, thanks in large part to the rise of China's economy (which isn't going away anytime soon), it makes sense that housing prices have skyrocketed in recent years.
Posted by: Ryan Petersen at Feb 15, 2008 11:46:39 PM
"Your whole first paragraph makes it seem like you don't understand what we are doing. We are comparing the difference between owning and renting. Clearly that requires a measurement of the opportunity cost of the large initial payments made in purchasing a home." No, it really doesn't, because those large initial payments don't have to be made. There's 80/20 financing, 97% financing, home equity lines of credit, etc. which mean you don't have to put a big chunk of money down in order to own a home. In my opinion you usually *should* do so, because you shouldn't gamble on the fact that the stock market, after taxes, is going to beat your guaranteed return from paying down your mortgage. But your numbers assume otherwise, that you can receive a 10% return from the stock market after taxes and with no discount for risk.
This is a fundamental flaw in your calculations. 30 years from now under your calculations you are saying that the homeowner will be content to have no mortgage on his now appreciated house even though he could take out a new first mortgage and borrow at a rate below the discount rate. That's nonsense. Just 10 or 20 years down the road it would be in the best interest of that homeowner to refinance with cash out or take out a home equity loan if he believes the stock market can return a 5% real return. In fact, with a real rate of return of 5% (after taxes) it's probably even in the best interest of the homeowner to take out an immediate 125% home equity line of credit and invest it in the stock market. And taxes are a huge issue as well. You can drop that 5% real return down to 3% just due to taxes, and that's assuming an average marginal tax rate.
"Adjusting the numbers to your desired 4% inflation and 9% return" I never said a 9% return was reasonable, after taxes. But if you're going to assume a 9% return, then what's the rate on a 125% home equity line of credit? I'm pretty sure I could get one under 9%. And what's the tax rate?
Posted by: Anthony at Feb 16, 2008 7:52:53 AM
Ah, here we go: My credit union has a variable rate home equity line of credit set at the prime rate for up to 100% LTV. Can we assume that the prime rate will, on average, be significantly less than 5% above inflation? I definitely can't let you claim a rate of return on investments above the prime rate. And after taxes I can't even give you that.
And out of curiosity, would you recommend I take out a HELOC at this prime rate and invest it in the stock market? Isn't that the kind of thinking that got us into this mess in the first place?
Posted by: Anthony at Feb 16, 2008 8:56:34 AM
Part of the problem was that there was a credit bubble. For years there has been too much credit available for the lower classes. They have proven themselves to be an unworthy and unreliable risk. This latest crisis - and the one that is to come due to credit card debts - is caused by the poor. Another contributing factor to this economic disturbance is the misguided attempts of Democratic governments at all levels to provide "affordable" housing. Government has no business trying to guarantee a home to every family in America; there are too many people out there that can't afford it. And if a buyer can't afford a home then he shouldn't be allowed to buy one. I don't want tax dollars used to subsidize homes for anyone. Investing in the poor is a losing proposition. I look forward to local and state governments - and maybe one day the US Congress - waking up to this realization. In the meantime the market will do a good job of correcting the excesses that have been present these past few years.
Posted by: Lyn at Feb 16, 2008 1:52:56 PM
Isn't the key tha