THE FINANCIAL PAGE
SAFE AS HOUSES?
Issue of 2006-10-30
Posted 2006-10-23
In the past few months, it’s been almost all bad news for the housing market. Homebuilders have had to tell Wall Street that between twenty and thirty per cent of their contracts have been cancelled. Janet Yellen, the head of the Federal Reserve Bank of San Francisco, has said that streets full of unsold new homes now make parts of Phoenix and Las Vegas look like “ghost towns.” Selling a home takes longer than it used to, and the inventory of existing homes for sale has gone up almost forty per cent in the past year. Yet, through it all, one fact has continued to provide solace to anxious homeowners and real-estate brokers alike: housing prices have stayed remarkably stable.
The lesson we’re supposed to take from this is that a home remains as solid and safe an investment as ever. After all, we’re constantly told, you have to go back to the Great Depression to find a full year in which housing prices fell. Unfortunately, the numbers upon which these comforting conclusions depend—namely, median home prices for the country—are unreliable and misleading.
There are plenty of statistics available about the housing market, but median home prices, which are tracked by both the National Association of Realtors and the Census Bureau, are what typically make headlines. They seem to tell buyers and sellers exactly what they want to know: how much the one has to spend, how much the other stands to make. The N.A.R. says that median sale prices for existing homes have risen fifty-seven per cent since 2000, and in many markets the increase has been much bigger than that.
Although these numbers come from an association that has a vested interest in making the housing market look healthy, they do provide a roughly accurate picture of how housing prices have behaved in the past six years. But if you’re trying to figure out what kind of investment housing is—what rewards you can expect and what risks you’ll run—median prices become a lot less useful. In the first place, the data don’t adjust for improvements in quality. People have been building bigger homes—the typical new home is about twenty-five per cent bigger than it was twenty years ago—and putting money into improvements like central air-conditioning, home theatres, and pools. And the impact of quality adjustments isn’t trivial; a study of home prices between 1977 and 2003 found that adjusting for quality reduced the return to homeowners by forty per cent.
As for the much vaunted statistic about housing prices never falling for a full year since the Depression? That’s true only if you forget about inflation. When you adjust for it, you find long stretches when housing prices tumbled and then stayed low for years; nationally, real home prices were actually eight per cent lower in 1991 than they were in 1979. What makes the problem worse is that sellers have recently been offering buyers huge incentives, ranging from granite counters to free cars and, in some cases, large rebates. These are, in fact, price cuts, but they never make it into the data.
Then, there’s the problem of sample bias. When you hear that housing prices in a city have gone up, you assume that all the homes in the city have become more valuable. But the numbers reflect only the homes that were actually sold in a given month, and, if more of those homes happen to be expensive, it’ll make the market as a whole look strong even if it’s really quite weak. This is what leads to the curious phenomenon of median prices rising even as the number of sales is plummeting and the backlog of houses on the market is soaring.
Because nominal median prices compare completely different groups of homes (all those sold in August, 2005, say, and all those sold in August, 2006), they can overstate how much prices go up during booms and understate how much they go down during busts. Luckily, there are other measures we can use. For example, the government compiles one index that tracks the repeat sales of homes that have mortgages with Fannie Mae and Freddie Mac, and another index that measures new-home sales while controlling for quality. The economist Robert Shiller, meanwhile, has created an index that controls for quality by tracking repeated sales of the same houses over more than a century. Together, these numbers give us a better picture of what happens to housing prices over time. And though they show that housing prices have risen sharply in the past decade, they also show that, over the longer haul, investing in a home is far from a sure thing; if you control for inflation and quality, Shiller found, real home prices barely budged between the eighteen-nineties and the nineteen-nineties. The idea that housing prices have nowhere to go but up is, in other words, a statistical illusion.
It’s an illusion, though, that has powerful effects. Clearly, it encouraged the speculative buying of the past few years. And it has also made sellers remarkably hesitant to cut prices, which has led to the huge backlog of unsold properties. Eventually, sellers are bound to realign their expectations with reality by trimming their asking prices. That will hurt people who were fooled into reckless speculation by assurances that investing in houses offered risk-free rewards. For most people, however, a decline in prices needn’t be so painful. If you’re planning to sell your home and buy another one, an over-all decline in housing prices leaves you no poorer than before. And, if you’re staying in your home, a drop in value can actually make things easier by lowering property taxes and insurance costs. Look at the bright side: at least you’ve got a roof over your head.
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