Wednesday, June 10, 2009

Why home prices change so slowly

In Saturday's New York Times, Robert Shiller examined why home prices change so much slower than stock prices:
HOME prices in the United States have been falling for nearly three years, and the decline may well continue for some time. ...

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. Why would a sensible person watch the value of his home fall for years, only to sell for a big loss? Why not sell early in the cycle? If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter. ...

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market. ...

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. ... In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn.

This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting and predictable. ...

Even if there is a quick end to the recession, the housing market’s poor performance may linger. After the last home price boom, which ended about the time of the 1990-91 recession, home prices did not start moving upward, even incrementally, until 1997.


  1. This may seem inconsequential or irrelevant - but even legislation such as the new Appraisal rules contribute to slow down any significant changes in the market. Appraisers are careful to err on the side of calling a price too low rather than too high. As such, it makes it extremely difficult for prices to climb - since everything is based purely on the recent comps (which are nearly all REO's here in SoCal) and the appraiser's opinion of current market stability (whether trending up or down). With this as the case, an FHA buyer who wants to pay $250,000 for a house can't get a loan funded unless the appraisal comes in at $250,000 or better. Which makes sense until you see how conservative appraisers are being right now.

  2. Juliius,

    So you are saying that homes SHOULD be priced higher than what they currently are?

  3. Heh - yeah, I guess my post does appear to imply that. No, I believe homes need to (and will) continue to come down in value. However, some sectors, such as the lower price range have already hit what is an acceptable rent vs. buy ratio. With regards to prices changing slowly - my comment was simply that the new appraisal guidelines will be another contributing factor to the slow price changes.