The real estate market continues to be the Big Standoff between sellers and buyers here during the dog days of summer. While waiting for the action to resume, here’s food for thought, from David Leonhardt at the nytimes.com:
Of all the uncertainties in our halting economic recovery, the housing market may be the most confusing of all. At times, real estate seems to be in the early stages of a severe double dip. Home sales plunged in July, and some analysts are now predicting that the market will struggle for years, if not decades.
Others argue that the worst is over. As Karl Case, the eminent real estate economist (and the Case in the Case-Shiller price index), recently wrote, “Buying a house now can make a lot of sense.”
I can’t claim to clear up all the uncertainty. But I do want to suggest a framework for figuring out whether you lean bearish or less bearish: do you believe that housing is a luxury good and that societies spend more on it as they get richer? Or do you think it’s more like food, clothing and other staples that account for an ever smaller share of consumer spending over time?
If you believe housing resembles a luxury good, then you’ll end up thinking house prices will rise nearly as fast as incomes in the long run and that houses today aren’t terribly overvalued. If housing is a staple, though, prices will rise more slowly — with general inflation, as food tends to.
The difference between these two views ends up being huge, and it’s become the subject of an intriguing debate.
After digging into it, I come down closer to the luxury good side, which is to say the less bearish one. To me, housing does not rank with unemployment, the trade deficit, the budget deficit or consumer debt as one of the economy’s biggest problems. But you may disagree.
No one doubts that prices rose roughly with incomes from 1970 to 2000. The issue is whether that period was an exception. Housing bears like Barry Ritholtz, an investment researcher and popular blogger, say it was. The government was adding new tax breaks for homeownership, and interest rates were falling. These trends won’t repeat themselves, the bears say.
As evidence, they can point to a historical data series collected by Mr. Case’s longtime collaborator, Robert Shiller. It suggests that house prices rose no faster than inflation for much of the last century.
The pattern makes some intuitive sense, too. As people become richer, they spend a shrinking share of their income on the basics. Think of it this way: someone who gets a big raise doesn’t usually spend it on groceries. You can see how shelter seems as if it might also qualify as a staple and, like food, would account for a shrinking share of consumer spending over time. In that case, house prices should rise at about the same rate as general inflation and well below incomes.
Here’s the scary thing, at least for homeowners: if this view is correct, house prices may still be overvalued by something like 30 percent. That’s roughly the gap between average household income growth and inflation over the last generation.
It’s also the overvaluation suggested by Mr. Shiller’s historical index. Today, it is around 130, which is way down from the 2006 bubble peak of 203. But it’s still far above the 1890 to 1970 average of 94.
In effect, the bears are arguing that housing was in a multidecade bubble and has now entered a multidecade slump.
The second, less bearish group of economists doesn’t buy this. This group includes Mr. Case, Mark Zandi of Moody’s Analytics and Tom Lawler, a Virginia economist who forecast the end of the housing boom before many others did. They say they believe that house prices rise nearly as fast, if not quite as fast, as incomes, and that real estate is no longer in a bubble.
This side can also make a case based on history. Mr. Case points out that all pre-1970 housing statistics are suspect. By necessity, Mr. Shiller’s oft-cited historical index is a patchwork that relies on several sources, like Labor Department surveys. These sources happen to paint a more negative picture of past house prices than some other data.
For example, the Census Bureau has been asking people since 1940 how much they think their houses are worth, as Mr. Lawler noted in one of his newsletters. The answers suggest that house values rose faster than general inflation — and about as fast as incomes — not just from 1970 to 2000, but from 1940 to 1970, as well.
Likewise, Mr. Case has dug up sales records for houses in the Boston area that were built in the late 19th century and are still around. The records show prices rising 2.5 percentage points a year faster than inflation, which is just about what income has done.
Perhaps most persuasive is a statistic that Mr. Shiller sent me when I asked him about this debate. It shows that the share of consumer spending — and, by extension, of income — devoted to housing has not fallen over time. It has hovered around 14 or 15 percent for the last 60 years. The share of spending devoted to food, by contrast, has dropped to 13 percent, from 25 percent.
These numbers make a pretty strong argument that the post-1970 period is not one long aberration. As societies get richer, they do spend more and more on housing.
Some of this spending, Mr. Shiller notes, comes in the form of bigger, more expensive houses. These houses don’t do anything to lift the value of a smaller, older house — which is what matters to individual homeowners. But McMansions are not the only factor.
To see this, you can look at the share of consumer spending devoted to things inside houses, like furniture. As with houses, they have become fancier. But they haven’t become so much fancier that they make up anywhere near as large a share of consumer spending today as in the past. That’s a strong clue that the upgrading of houses themselves isn’t enough to explain the increased spending on housing.
What is? The value of the underlying land. Those Boston-area houses that Mr. Case studied did not change much over time. Yet their value did.
For a house whose location has any value — in a major city or a nearby suburb, where a builder can’t simply put up a similar house down the street — the land is a big part of the equation. Over time, Mr. Zandi says, the value of that land should grow almost as fast as the local area’s economic output or, in other words, with incomes.
The best advice for homeowners and would-be buyers may be to think of a house not as an investment, first and foremost, but as a place to live. If there is a good chance you will move in the next three years or so, you should probably rent. The hassles of buying and the one-time costs are just too big. Plus, house prices are not low in most places today.
The ratio of median house price to income is about 3.4, compared with a prebubble average of about 3.2. Given the economy’s weak condition and the still high number of foreclosures, prices may well fall more in the next year or two. They look especially high in places where rents are comparatively cheap, like San Diego and San Francisco. And maybe income growth will remain weak for years, holding down home-price growth.
But if you can imagine staying much longer than a few years, you should take some comfort in the fact that the bubble seems mostly deflated. Sometime soon, prices should begin rising again. They may not quite keep up with incomes, but they will probably outpace the price of food and clothing.
Now, if only it were possible to be as sanguine about the economy’s other problems.
*Grin* I’m thrilled you don’t have a video up, Jim, as–for some reason–my speakers are MIA. But I can’t wait to read the discussion on this topic.
I’ll be happy with the real estate market when all the free renters are kicked to the curb. It’s impossible to value a market when a large percentage aren’t true owners. As a buyer the large number of free renters represent a strong possibility that the number of houses for sale will increase in the future. Larger supply = lower overall price. Government can’t float the house market to infinity. (even though they think they can) Eventually sanity will come back just like it did after the Savings and Loan junkbond fest of the late 80’s early 90’s.
it’s a staple, remember we had dual income families after the 70’s so they spent like crazy on housing.
While an interesting theoretical discussion, at some level, but I think the conclusion that housing hasn’t fallen as it should is incorrect. If we assume that the total percent of the household budget is 100% of income (yeah, yeah, housing ATM assumed closed), then what has dropped? Everyrhing we can off-shore: Food, Clothing, Home Furnishings. Instead of these items being by and large made by U.S. farmer or artisans or companies, they are created overseas and imported to the U.S. at a lower relative cost. (I don’t offer any real opinion on whether this is a good thing or bad thing, that’s besides the point.) The other items: Education, Housing, and especially Health Care, are by and large things we have to consume here. Two of them: Health care and Education have gone up, one has stayed about the same. So, I don’t really think its fair to assume real estate will drop like food, etc. Real estate prices may go up, they may go down, but I really don’t think affixing a label like “luxury item” is going to drive the boat here.
I think perhaps it’s presumptive to believe wages will go up. There seems to be a progressive movement to break up public employee/government unions to balance state/municipal budgets. If that happens, wages and benefits will regress and coupled with lax immigration policies creating a pool of cheap labor, I don’t see luxury on the horizon. There’s too much downward pressure, which for the time being, will keep us in deflation, stimulus be damned.
Having said that, there’s still a pervasive belief on the part of sellers that the top of the market in ’07, is the benchmark for prices to springboard upward from. Real estate ALWAYS goes up, right? As long as that mentality exists, this will be an ADHD market dominated by speculators and impatient first-timers. It’s musical chairs and when the music stops…ouch!
To put things in perspective, I make median income for a single person and single-family homes in my zip are *AT LEAST* 8x my gross annual income. Townhomes are *at least* 4.5x. I can however afford an entry level converted apartment. The sunshine tax is too rich for my blood so other states look VERY attractive to me…
Income is flat and has been for more than a year.
http://www.bls.gov/news.release/pdf/realer.pdf
I don’t see housing prices trending upwards until income trends upward.
There’s an interesting chart from calculated risk (2 years old) that shows the median home price to household income… I’d love to see a more up to date version of this chart but it looks like the most recent census data is from 2008.
http://www.calculatedriskblog.com/2008/11/house-price-to-income-ratio.html
I guess I agree with the idea that home prices track income, not inflation/CPI. But as long as income is flat or declining, home prices will NOT be trending up.
Real estate is just like any other asset.You buy when everyone else throws in the towel.Right now everyone hates real estate.The smart money is buying and they will be selling to the dumb money(avg joe) soon enough.Happens everytime people.Look at the stock market dip.the people who bought during tha panic made some pretty good cash.Real estate takes longer to turn the ship around.
Mortgage Interest rates have been heading down for the last 30 years. In 1980 a mortgage was 15% interest now it’s less than 5%. This is an aspect of buying power that could explain the last 30 years as an aberation. I.e. Housing value is a product of interest rate, wages, and down payment.
April 2010 might have been absolute best combination of leverage (FHA with tax credit) and interest rates we’ve ever seen. I suppose we could give money to people to take a house and lower interest rates a little bit more, but it’s probably pretty close to the lowest possible monthly payment without lowering prices more.
So if interest rates go up what happens to prices? A low price is more important than a low interest rate. You can refi a rate. Yes some areas in SD county seem pricey, people still want RE and compete for it. Room to fall? of course – could it go up? – of course. Where is my crystal ball?
I’d tend to agree that housing has swung from being simply a staple to a luxury. That said, I believe that’s a reason to be MORE bearish and not less, as the pendulum is in the process of swinging back. The past few decades were an aberration, and that swing was a part of it.
Same thing with the stock market. It used to be all about dividends, but then equity increases became all the rage. In the end it’ll be back to dividends again.
I think it will be a cold day in h@ll before the govt lets interest rates go up drastically.You have the fed buying treasuries as well as the banks.The govt knows if rates go up this recovery will really nose dive.Some areas in phoenix are off 70-80%.You can buy a house in some areas for the price of a nice new car.Great buying opportunities in some areas.Prices in san diego are not going to crash.Way too much demand.
“I think it will be a cold day in h@ll before the govt lets interest rates go up drastically.You have the fed buying treasuries as well as the banks.The govt knows if rates go up this recovery will really nose dive.”
What would you consider drastic, 5%, 6%? 30 year fixed in September 2008 was 6.04. That was just 2 years ago.
Going from 4.5% to 6% translates to about 15-20% less purchasing power. I.e. 380K @ 4.5% = 325K @ 6% in terms of monthly payments.
Here’s a link to historical interest rates if you care.
http://www.freddiemac.com/pmms/pmms30.htm
Excuse me?? Scapegoating labor unions and public pension plans has been an authoritarian (née “conservative”) staple and article of faith since at least FDR. (Show me a single “conservative” advocating for raising the wages of public employees or strengthening public pensions.)
That aside, I think your overall thesis is correct — I’m seeing no evidence that wages are headed upward. At the same time, as you observed, real estate prices are not (yet) falling enough to be within realistic reach of median-income workers.
I am in Sonoma County,and we have two major price tiers. There is one where the buyers work for a salary and one for the wealthy. Homes here were at 12x income for a 20 year ok tract home in a decent neighborhood,those prices have dropped to 5 or 6x the median income. And the local economy is worsening. Expensive homes were overbuilt and quality is all over the map. Anything of good quality that is priced right will move right away,anything priced even a dollar too high will sit,even with price reductions in most cases.The rich are doing well and genuinely fine properties will do well,the rest,no.
I think homes today in NCC are a luxury item based on rent vs. buy.
To make sure I wasn’t losing my mind, I recently asked my dad how he came to the conclusion to buy his first house in 1974. Being the engineer he is, he had a long, drawn-out, carefully calculated explanation. But the first words out of his mouth were, “well it was a no-brainer.” That’s all I needed to hear.
Here’s a stupid question: Have you always been able to buy a house with less than 20% down? Am I the only moron who thought you need 20% down to buy a house? Chalk me up as another buyer who recently got screwed by a more aggressive FHA buyer. If we ever get back to the concept of a down payment, prices are sure to go down further.
ewhac…you’re mistaking my use of the term “progressive” to equate a liberal mindset. I simply used the word to illustrate forward momentum. Is that better? 🙂
Great post in #5, common-sense. Couldn’t agree more: there will be no relevant wage increases for a long, long time, IMHO. The decimation of public employee unions will affect wages of U.S. workers across the board because private employers have had to compete with public employers. Too many people don’t understand this, much to their own detriment.
The Blur,
Hehe, no I thought the same thing. I thought FHA was only for low income folks and that you had to have under a certain income to qualify otherwise you needed 20% down. That of course was before I started looking into it, but it was my default assumption while renting (and in no position to buy due to frequent job changes).
Former RB Resident-The US is a significant net exporter of food. That’s not going to change any time soon.
I assume that in the US (like in South Africa) the cost of house components (bricks sticks concrete and the man with the shovel and hammer) go up every year. Is cement more expensive today than 2007? Board feet of lumber? Quarts of paint? Sheets of siding? If it IS more expensive then house prices WILL rise as the replacement costs rise.
Excellent write up Jim,
I’m with #16. Wages are stuck like glue (I really, really hope they don’t fall in real terms but they could do that too) and will be flat (imho) for several years. If food and gas rise that means the house part of the budget will get reduced and that means house prices have to fall. Time will tell.
My suspicion is if you held the size of the house constant it would tend towards the staple point of view. However new home sizes have increased until recently, and now are decreasing implying that to some extent homes of the sizes of the mid 2000s were somewhat luxury goods. Clearly some amenities in a home such as “granite” (often gabbro) countertops classify as luxuries. Now some things such as dishwashers that used to be luxury are now staples. So the answer is YES
Shelter is a staple, purchasing your shelter is a luxury….especially when you consider the uncertain future of healthcare costs (which will most likely increase dramatically – trends will continue no thanks to the current administration), stuck wages (who is getting a raise and in some cases a job?) and future retirement benefits (social security has not kept up with inflation). Unless rents begin to increase (I doubt this trend) why purchase at inflated prices? – my prediction is we will be at late 90s pricing when this market completely adjusts.