Monday, June 15, 2009

U.S. home prices not so overvalued anymore?

I've created a new graph, which compares national home prices to national owner-equivalent rents. These are not dollar values, but index values with Q1 1997 equal to 100.

Click on the graph to see a full-sized version:


According to this graph, the national price/rent ratio is 10.7% higher than in Q1 2007. I haven't built a graph for the D.C. area yet, but running the numbers shows that the D.C. area price/rent ratio is 21.6% higher than in January 1998. (D.C. area rental data only goes back to December 1997.) Even worse, New York City area price/rent ratios are 38.2% higher than during January 1997. Of the twenty metro areas that the S&P/Case-Shiller Home Price Index tracks, New York and Washington are the slowest decliners. This is why I believe New York and Washington will bottom later than the country as a whole.

In the past I have argued that home prices don't overshoot, but the trajectory of the graph above suggests that in time I may be proved wrong. The current trajectory seems to suggest we are in for massive overshooting. You have to buy foreclosed homes or short sales to get the bargains, though.

24 comments:

  1. I live in montgomery county...and I rent a townhouse. Im confused by this graph as I know what my rent is....and I also know that if I bought my mortgage alone would be almost triple my rent. Not even calculating the taxes and maintenance costs.

    If a mortgage would only cost me 10% more than rent, I would have bought already.

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  2. "Of the twenty metro areas that the S&P/Case-Shiller Home Price Index tracks, New York and Washington are the slowest decliners. This is why I believe New York and Washington will bottom later than the country as a whole."

    Then why do you think case shiller rate of decline in DC is decelerating (4 months straight)? I think San Diego is the only other city doing that.

    Why is our (NOVA) inventory at 2005 levels whereas nationally its near all time highs.

    Why are median price declines in every NOVA county declerating - except the immune arlington where they once again turned positive (+11% YOY).

    These are all legitimate questions - im not trying to snark. I am curious what you think about that.

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  3. Anonymous said...
    "These are all legitimate questions - im not trying to snark. I am curious what you think about that."

    Well, if you really want my thoughts on the issue, don't comment as anonymous. Create an account and log in. I won't answer your questions as long as you ask using "anonymous" as your screen name.

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  4. I can see some positive from your graph. Owner equivalent rents appear to be rising quite steadily since 1983. The house price line also appears to touch the rental index at the tail end of the aftermath of Savings and Loan crisis. I am curiously to see of the same is going to be true of our current situation. If it does not, does that mean that our free market economy has been interferred with too much by government?

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  5. I wouldnt give up on your "it wont undershoot" argument just yet. Take a look at that PWC price graph you showed us a few months ago.

    http://www.recharts.com/mris/mris_9.html

    That area looked certain to overshoot as late as october 2008. I never expected such a severe and quick turn to flat (and maybe even positive).

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  6. "Overshooting" would only apply if the economy were the same as before. Since 1987, the industrial base has been wiped out,wages have declined relative to inflation and inventory has skyrocketed. In short this is not going to be anything like past recessions. Anyone not taking these factors into account is either blind or an economist.

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  7. Anonymous said:
    "I live in montgomery county...and I rent a townhouse. Im confused by this graph as I know what my rent is....and I also know that if I bought my mortgage alone would be almost triple my rent. Not even calculating the taxes and maintenance costs."

    James isn't saying cost of owing is 10.7% higher than renting. He's saying that an index of buying vs renting is 10.7% higher today as compared to 1997. Or such is my understanding.

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  8. "Overshooting" would only apply if the economy were the same as before.

    This is true in real dollar value terms, but if you're talking about overshoot based on a price vs rent index that should account for changes in wages.

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  9. to anonymous.

    dude. housing prices are still DECREASING. so what if the decrease in housing prices is decelerating? what does that have to do with when DC will hit bottom? guess what? if the prices keep decreasing, but the decreases stay at 10% YOY, the PRICES ARE STILL DECREASING AND YOU STILL HAVEN'T HIT BOTTOM.

    and p.s. I'd like to see what the true inventory is, which includes all of the houses that should be in foreclosure that banks have been holding back from putting into the market.

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  10. kahner said...
    "James isn't saying cost of owing is 10.7% higher than renting. He's saying that an index of buying vs renting is 10.7% higher today as compared to 1997."

    Correct.


    Nashville Real Estate said...
    "Owner equivalent rents appear to be rising quite steadily since 1983."

    Keep in mind that all you're seeing is inflation, but in this case it's inflation of only owner-equivalent rents, rather than inflation of all consumer prices.


    Nashville Real Estate said...
    "The house price line also appears to touch the rental index at the tail end of the aftermath of Savings and Loan crisis."

    Keep in mind that these are index values, not prices. The point at which the two lines intersect is arbitrary. The two lines intersect at January 1997 because I chose to have them intersect at January 1997.

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  11. I cant wrap my head around what you guys are talking about. All I know is rent the townhome I live in, $1500 a month....buy a townhome in my subdivision, $3450 a month. What kinda index is that? All I know is that it isnt a 10% difference.

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  12. "dude. housing prices are still DECREASING. so what if the decrease in housing prices is decelerating? what does that have to do with when DC will hit bottom?"

    They need to decrease before they hit bottom, be it next year or next decade. Here they are decelerating. In the US they arent yet. Thus my conclusion we are ahead of the US.

    "and p.s. I'd like to see what the true inventory is, which includes all of the houses that should be in foreclosure that banks have been holding back from putting into the market."

    I would too. DC inventory says we are at pre bubble levels. Add in the phantom inventory, and im sure its much higher. US inventory says its near peak. Add in the phantom inventory and im sure its much higher...

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  13. "They need to decrease before they hit bottom, be it next year or next decade. Here they are decelerating. In the US they arent yet. Thus my conclusion we are ahead of the US."

    Yeah well the only problem to that conclusion is that homes in the DC area are still about 6 or 7 times the average annual income. So if they dont decrease and we reach a bottom before the nation does, prices will stay the same for about 900 years.

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  14. Anonymous said...
    "I cant wrap my head around what you guys are talking about. All I know is rent the townhome I live in, $1500 a month....buy a townhome in my subdivision, $3450 a month. What kinda index is that?"

    That's not an index. It's a price. See the little dollar sign? That means price, not index.

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  15. "That's not an index. It's a price. See the little dollar sign? That means price, not index."

    As I said, I cant wrap my head around what you are talking about. I wasnt being a smart ass.

    So if prices aren't what makes the index, what is unicorns and leprechauns? (yeah now Im being a smart ass)

    If the index is based on inflation and price....fine. So lets go on that....

    My rent $1500, my rent 10 years ago, $1100.

    Mortage on townhome nextdoor, $3500. Mortgage on the same townhome 10 years ago $950.

    So 10 years ago, a guy who bought a townhome and rented it out could actually profit. Today that same guy would be better off to be renting his house than buying and renting properties to others.

    I still dont understand where that 10% comes from.

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  16. "Yeah well the only problem to that conclusion is that homes in the DC area are still about 6 or 7 times the average annual income. So if they dont decrease and we reach a bottom before the nation does, prices will stay the same for about 900 years."

    6 or 7 times income. In a few areas, perhaps, but not for most of the region.

    You also need to check and see what rates were pre bubble - in some areas you would be horrified (especially close to the city where high renter percentage skews the average). In some places the bottom last time around was 8-9X income. Thats where it should end up this time around.

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  17. "6 or 7 times income. In a few areas, perhaps, but not for most of the region."

    Im talking DC proper and the MD area, not west of the Dulles airport


    "In some places the bottom last time around was 8-9X income."

    10 years ago the townhome I rent would have been about $100K, it goes for $590K today. I could have bought my townhome with cash 10 years ago, had I lived in this area back then. I dont care what the rates are, I dont live day to day, if the rates are high, I would pay my home off.

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  18. Housing is a market, and markets overshoot. It's not as visible in housing because of its nature -- monthly data points and seasonality -- creating a blur.

    And everything depends on what values you are comparing. When you get down to it, defining what a house is really worth other than the selling price is nebulous at best. The same is true in stocks and other investments.

    I think it is fair to say by whatever metrics we choose to invoke that a house purchased now will be worth less in the future.

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  19. "James said...New York and Washington are the slowest decliners. This is why I believe New York and Washington will bottom later than the country as a whole."

    Couldnt it just be they have improved the most. Last month you were chastizing that one guy for expecting everyone to get down to 1998 levels, regardless in changes in income or local economies.

    Really, arent you just doing the same thing as him, but in reverse?

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  20. Anonymous said...
    "I wasnt being a smart ass."

    I know you weren't. I was being a smart ass, though. Sorry.

    An index just measures the amount of change from one point in time to another. Think of the Dow Jones Industrial Average, which is an index. You can't buy the Dow. It's not a stock or mutual fund. It's an index created to measure how much the stock market changes from day-to-day or from year-to-year. If the Dow was at 12,000 a year ago and it's at 8,500 today, you can do a little math to figure out that the stock market has fallen 29% over the past year. Keep in mind that 8,500 is not a price, because YOU CANNOT BUY THE DOW. The Dow is just a way to measure how much the stock market changes over time.

    Quite often, an index is set to have the value on a particular date equal to either 1.0 or 100. I chose January 1997 as the date both the house price index and the rent index would be 100. It does not mean that a house could be bought for the same price as it could be rented on that date.

    I don't have access to my spreadsheet data right now, but if today the rent index is at 140, then I can figure out that in the U.S. as a whole rents have risen 40% since January 1997. If the house price index is at 160, then I can figure out that house prices in the U.S. as a whole have risen 60% since January 1997. Normally, rents and home prices should rise at the same rate.

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  21. Brala said...
    "Couldnt it just be they have improved the most."

    No, because if the house prices changed due to actual improvements, then the rents should have changed at roughly the same pace. If an area improves due to gentrification, for example, you would expect house prices to increase at a faster-than-normal rate, BUT YOU WOULD EXPECT RENTS TO INCREASE AT AN EQUIVALENT RATE.

    Over the long run, rents and home prices should increase at roughly the same pace, but as the graph above demonstrates, in the short run they can diverge wildly. I believe the graph also demonstrates that rents are a far more reliable indicator of value than home prices, because rents tend to swing far less wildly than home prices.


    Brala said...
    "Last month you were chastizing that one guy for expecting everyone to get down to 1998 levels, regardless in changes in income or local economies."

    That's a misleading claim. Nonpartisan said that "other markets" (plural) had fallen back to mid-1990's nominal levels. I pointed out that only one market tracked by the S&P/Case-Shiller Home Price Index had done so. That market is Detroit, which is experiencing a collapsing auto industry.

    I could be wrong, but I believe home prices in Detroit have overshot to the downside, and will eventually come back up when the economy recovers. It all depends on the success of the auto industry bailout, however.

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  22. Living on the farther reaches of Rockville, I'm not seeing affordable prices the way I used to see them. 500K + for a townhome? I don't think so. If prices don't drop in Mont. County soon, and to realistic levels, I see no reason to stay here when it comes time to buy. I won't be the only one looking to move out of county, either.

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  23. "Living on the farther reaches of Rockville, I'm not seeing affordable prices the way I used to see them. 500K + for a townhome?"

    Thats what I was talking about.

    The townhome I rent for $1500 a month would be listed for $590K this very moment. 10 years ago, it would rent out at probably $1100 a month, but you could purchase it for $100K.

    As a matter of fact, townhomes in this area, during the bubble were only about $20K more than they are now 2 years ago. Rockville hasnt dropped at all and Potomac has actually INCREASED in price since the bubble!


    I think this graph is talking about LA and Miami only.

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  24. The graph is about the entire USA.

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