The graph above is making the rounds again, this time spurred by a post from Dave Altig of the Atlanta Fed:
Prior to the crisis, I was persistently advised that the better way to think about the “right” home price is to focus on price-rent ratios, because rents reflect the fundamental flow of implicit or explicit income generated by a housing asset. In retrospect that advice looks pretty good, so I am inclined to think in those terms today. A simple back-of-the envelope calculation for this ratio—essentially comparing the path of the S&P/Case-Shiller composite price index for 20 metropolitan regions to the time path of the rent of primary residences in the consumer price index—tells a somewhat different story than the New York Times chart used in the aforementioned Ritholtz blog post…
The Ritholtz post in question includes a version of the graph updated to include more recent data. Go on over to the Altig post linked above to see it.
When I look at that graph three things leap out at me. First, there’s the obvious housing bubble of the middle Aughts. The second thing is the substantial jump following World War II. I think that leap can be explained by several developments: technological advances in housing construction, e.g. pre-fab, increasing use of 30 year mortgages, VA loans, and demographics.
What explains the jump following the First World War? Prior to the creation of the New Deal FHA and the invention of 30 year mortgages by Amadeo Giannini of Bank of America, the normal term for a home mortgage was anything between five and ten years. After that period the borrower would need to renegotiate. When was the 20 year mortgage introduced?
The explanation I’ve heard for the jump was (unspecified) technological advancement in home construction. I think it may have been the automobile.
The point I’m getting to in all of this is what is the correct, normal level for home prices? Does a reversion to mean suggest a return to the post-World War II mean? Why is that normal?
I think the markets will revert, but in a different sense, to “real estate is local.” Some places were overbuilt, and there isn’t a quick fix for that. Other areas have remained in high demand. They’ll probably stay strong.
I have my eye on some weak areas, but feel no rush.
It wouldn’t surprise me if the national prices slid some more, but I think those will reflect the known weak areas.
Living outside a major metropolitan area, this graph always looks like readings from an alien planet. I bought my house at the beginning of the boom, and expect that today I could sell it for the same inflation adjusted price. I think these graphs tell us more about the major metros, than about housing.
Checking the inflation calculator and zillow zestimate, I’m also ahead of inflation, but 40% off peak!
“First, there’s the obvious housing bubble of the middle Aughts.”
Heh. Surely you jest. I’m sure you meant to say “the housing bubble that began in late 1996.”
Separately, once an engineer, always an engineer – The things that jump out at me are:
1. There is the usual volatility of any data stream, and obviously more factors at work than just rent/buy tradeoffs. Factors, by the way, that can be dominant for half a decade, or a couple decades. (Think real hard about that, folks. 1-2 decades?)
2. The two most striking inflection points outside the normal to and fro are Post WWII and 1996, and therefore those deserve special scrutiny. (And of course 1996 is just laughably outsized. Gonzo.) I think it would be hard for anyone to disagree with Dave’s observation on Post WWI as being anything but mostly complete. I think, at this point in time, political biases preclude a rational analysis of 1996.
And as to the essence of Dave’s query – “Does a reversion to mean suggest a return to the post-World War II mean? Why is that normal?”
No, it doesn’t, and it isn’t. IMHO the primary reason is increasing wealth and disposable income over time. However, this chart is now dated. We know it has pulled back dramatically by some, what, 40%? So some significant reversion is clearly in the cards. And of course the boomers have done boomed. But now they will concentrate in sunny, low tax retirement areas like Naples, FL, Scottdale, AZ, Asheville, NC etc. Local housing markets like that will buck general trends, but general indices will reflect the mean reversion. I doubt anyone gives a rats arse, but I see 10% more down.
Why? We have other issues to consider that will probably depress prices. Government is a spending addict: Increasing income, sales and property taxes will reduce available income to service mortgage debt – and hence support property values. The credit boomlet is over. Government inspired sub-prime lending is dead, for awhile at least. Inflation is eroding the stock of wealth, and increasing everyday expenses. I know that housing has traditionally been considered a “hard asset” inflation hedge. But the headwinds are huge right now. I don’t see an electromotive force supporting housing as an inflation hedge.
Its pretty bleak. JP – Sorry to hear about your loss of value. Me too, although not nearly to the same extent. But let’s personalize this (at the risk of offending sam). I’ve probably lost $150K of housing value. Do I care? Of course. Does it really matter? No. We pretty much knew we were buying our place at top tick. But there were lifestyle and aesthetics that were at play. But what about all those people who bought, oh, $400K to $700K homes that have lost $100K – $200K? That’s what I worry about, both from their personal financial planning/retirement aspect, and from the fiscal drag on the economy. For many, I’m not sure that wealth will be recovered in their lifetime.
And then there is the stock market……………..