What home prices would be without the bubble

[kev374]

Interesting article takes a look at what prices would be nationally and in CA if the bubble did not happen. CA median is off 61%!

http://homeguide123.com/articles/what_median_home_prices_would_look_like_if_the_bubble_never_happened.html?ref=patrick.net

[Ex-SD]

Article on the San Francisco Gate web site re. CA housing prices.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/02/14/BU5AV1K01.DTL

[Ex-SD]

Article on the San Francisco Gate web site re. CA housing prices.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/02/14/BU5AV1K01.DTL

[Ex-SD]

Article on the San Francisco Gate web site re. CA housing prices.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/02/14/BU5AV1K01.DTL

[Ex-SD]

Article on the San Francisco Gate web site re. CA housing prices.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/02/14/BU5AV1K01.DTL

[Ex-SD]

Article on the San Francisco Gate web site re. CA housing prices.

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/02/14/BU5AV1K01.DTL

[gdcox]

The analysis uses the average ratio of median income to median prices between the mid-70s and 2001 (2.8 ‘income multiplier’) to calculate the size of the current bubble.

Whilst I am no apologist for or denigrator of the theory of the bubble (it exists, is big and ugly and I would hang all brokers who sold 100% plus sub-prime loan to value mortgages in recent years!), there are in my view two notes of caution that needs to be applied regarding this bubble size work.

1) The period chosen (mid 70s to 2001) includes a first half when mortgage interest rates were abnormally high (for a variety of reasons). The abnormally high mortgage rates then (in nominal and real terms) had the effect of constraining the income multiplier because mortgage demand was unnaturally limited and hence prices were at a lower level . So I think the ‘normal’ multiplier is larger than 2.8 and hence the scale of the bubble today is smaller than the authors say.
2) As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse. I suspect that point is well above the level suggested in the article because rents have probably risen a more than have median incomes: eg I don’t think California will go down 60% (recent level to bottom as the article suggests) even if as seems likely foreclosure sales keep on rising.

I sadly do not have time to do the analysis suggested above, but I suspect that the factors above mean that the bottom is above the non-bubble average national, state or city price level stated in the article; though I am conscious that in some micro areas there will be a huge undershoot of prices simply because of the shear scale of new subdivisions put into the market by new build well away from centres of employment (eg DR Horton’s 50% fire sale) .

Have I missed anything?

Graham Cox

[Bugs]

One thing I’m starting to see at ground level is that the softening of the rental structure seems to be spreading.

In the past there have been periods were rents retracted a bit, although never anywhere near the extent that pricing has ebbed off of a peak. However, we’ve never had a period where rents have increased as quickly and as much as they did over the last 7 years. The ‘wealth effect’ became so pervasive in our economy that it even got into the rental market this time, whereas past increases were much more limited.

Depending on what happens in the general economy in this region over the next years I think there’s some possibility of the some significant rental declines. The mighty RE economic engine has derailed and the wages that are being lost there – directly and indirectly – aren’t coming back any time soon.

The bottom line is that regardless of how nice San Diego weather is, most people have no incentive to spend half of their gross income on their housing unless there’s a profit margin in the near term. Renters will always be acting in their own best interests and rental pricing is a huge consideration, so it will always be competitive.

So while I do expect pricing to level off when it nears parity with rental incomes, I also expect rents to retract some too. Just as with pricing, the desirable areas will be among the last where this happens, but if the general trend continues long enough it’ll eventually reach into those neighborhoods too.

[raptorduck]

Ex-SD. You beat me to the punch. I was just about to post that article.

[kev374]

gdcox, I disagree with you. The multiplier was the average and interest rates have not been high throughout the period. Furhter income growth in the last 7 years has lagged inflation and the long term trend is that there will be further depression on income on white collar jobs because of global wage arbitrage.

[Alex_angel]

Houses are only worth what people will pay for them bubble or no bubble. Simple economics.

If people didn’t want a $800k home then they wouldn’t buy it.

[Ex-SD]

There are two, little obstacles that buyers and sellers will have to overcome to buy and sell their properties in the bubble markets:
1. Get an appraisal that matches the selling price
2. Get a loan
Without either, you don’t have a sale (unless you have a cash buyer).

As prices continue to drop (and drop and drop), rents will also eventually drop. Bugs has it right in his post above.

[EconProf]

BobS
gdcox makes a valid point by challenging the income/house price ratio. Since the earlier period had artificially high interest rates, house PAYMENTS were unnaturally high. We all remember that Volcker had to use 15%+ interest rates as a battering ram to wipe out inflation and inflationary psychology. Housing was the collateral damage.
In contrast, the bubble was stimulated by unduly low interest rates for several years under Greenspan.
A better ratio might be income/house payments.

[cr]

Good points GD, and agreed Bugs. BobS, your point is good too, but payments can be mis-leading depending on the type of loan.

Rents cannot rise beyond incomes either. Rents may increase as the bubble deflates and could potentially lessen price declines, but both are ruled by income.

If incomes (stagnate at best, not to mention rising unemployment i.e. fewer people with those incomes) don’t keep up with the cost of either then both are overinflated. I can see how rents and prices could stay high for a while in a transitional period, and diminish in appearance the size of the bubble, but I don’t see how both can stay unaffordably high long enough for incomes to catch up. The same reason people are losing their homes will mean they eventaully can’t afford higher rents. Going into a housing-induced recession will eventually lead to a deeper drop in rents and prices, until incomes catch up. And if the past 2 bubbles are any indication, there will be an over-correction.

I think we will start to see people move away in droves from these high cost markets.

[Rich Toscano]

I am very skeptical of the idea that lower interest rates justify higher home prices. Let me throw a couple of thoughts out there haphazardly — this is an article I’ve wanted to write for a while so this is a good opportunity to get feedback on my thinking.

1 – The historical record doesn’t support it

Check out this graph: http://piggington.com/images/primer/sdpricetoincome.gif The p/i ratio peaked and trough at the same place in the prior two cycles, despite vast differences in rates. This time around, the difference was not rates but incredibly (and unsustainably) loose underwriting due to the securitization boom.

Also I did a quick regression and there was no correlation between rates and inflation-adjusted home prices from 77-2000. If you include the latest bubble there was a mild positive correlation but again, i think that’s due to underwriting. Not sure how to prove that thesis, except for the fact that falling yields never before affected the p/i ratio, so it must be something else.

BTW rates fell thru both of the prior downturns — http://piggington.com/historical_home_prices_payments_rents_rates — how does that fit in?

2 – Houses are long-duration assets, or something

This is the part I’ve had trouble describing coherently. For the individual making a rent/buy decision, lower rates are definitely a consideration (as long as you will be in the house for long enough to reap the benefits of locking in a low rate. There’s always the argument that you can refi in the future, but what if rates only go up from here?).

However, think about the market as a whole and future rate/price direction. If rates rise, they will put downward pressure on prices (maybe? see above – but let’s say they do) in the future. Given that rates are low, and in specific that real yields are unusually low, there is a good chance of rates rising — shouldn’t this future pressure be priced into the justifiable home price?

Or let me try to explain it a different way. When you buy a house, the future value of that house will be influenced by FUTURE rates, not just current rates. So just because rates have spiked down, does that suddenly argue that prices should be higher? I’d argue not.

Or a third angle: the “justifiable” price may be influenced by rates, but it has to be influenced by the average level of rates over the holding period of the home, not just rates right now. Hmm, I think that may be a better way to describe it.

You can see why I haven’t written about this yet. 🙂 The concept is clear in my mind but I don’t know how to explain it. Thoughts?

Rich

[Raybyrnes]

Rich,

It seems like you are simply describing housing as a bond yield calculation.

[Raybyrnes]

Rich,

It seems like you are simply describing housing as a bond yield calculation.

[Raybyrnes]

Rich,

It seems like you are simply describing housing as a bond yield calculation.

[Raybyrnes]

Rich,

It seems like you are simply describing housing as a bond yield calculation.

[Raybyrnes]

Rich,

It seems like you are simply describing housing as a bond yield calculation.

[denverite]

gdox believes that the late 70’s had unusually high mortgage rates, and that this had the effect of reducing home prices ( and therefore, the income multiplier). At that time I lived in SD and sold some properties. It is true that properties took a while to move, but not true that housing prices declined to any significant extent. The reason: creative financing. If an owner actually wished to sell, they became the lender (at reasonable interest rates typically around 7-8 percent). There were many such alternatives promoted by the real estate industry to keep the cash flow going. “Creative Fincancing” was truly a huge buzzword at the time.

Banks and other traditional lenders were used only as a last resort, though it surely did happen.

Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.

My, albeit biased, conclusion is that the thrust of the article remains intact.

[jpinpb]

I would just like to add that it wasn’t merely the low interest rates which caused the housing price to increase. I believe it is the direct correlation between the low monthly payment on the teaser rate that allowed people to buy more expensive homes they otherwise would not

The price increase is tied directly to the low teaser monthly payment. Some of those initial teaser rates allowed the mortgage payment to be just slightly higher than what rents would be.

All shortsighted, of course. No one thought about when the rate adjusted, or cared. They were going to flip or take money out or whatever.

There will be more people in the rental market as they get evicted from their foreclosed homes. Therefore, the vacancies will be low. I think the rents will increase because of the mere demand. Predatory renting, so to speak. People will stretch their budget for a while. But ultimately, it can only go so high compared to incomes.

My two cents.

[patientlywaiting]

I’m in agreement with jpinpb. The low teaser rates is what got people to say: “I can buy that house for just about the same as my rent. Plus I can resell and get rich.”

Bank were qualifying borrowers based on the teaser rate. Big mistake.

[patientlywaiting]

I’m in agreement with jpinpb. The low teaser rates is what got people to say: “I can buy that house for just about the same as my rent. Plus I can resell and get rich.”

Bank were qualifying borrowers based on the teaser rate. Big mistake.

[patientlywaiting]

I’m in agreement with jpinpb. The low teaser rates is what got people to say: “I can buy that house for just about the same as my rent. Plus I can resell and get rich.”

Bank were qualifying borrowers based on the teaser rate. Big mistake.

[patientlywaiting]

I’m in agreement with jpinpb. The low teaser rates is what got people to say: “I can buy that house for just about the same as my rent. Plus I can resell and get rich.”

Bank were qualifying borrowers based on the teaser rate. Big mistake.

[patientlywaiting]

I’m in agreement with jpinpb. The low teaser rates is what got people to say: “I can buy that house for just about the same as my rent. Plus I can resell and get rich.”

Bank were qualifying borrowers based on the teaser rate. Big mistake.

[jpinpb]

I would just like to add that it wasn’t merely the low interest rates which caused the housing price to increase. I believe it is the direct correlation between the low monthly payment on the teaser rate that allowed people to buy more expensive homes they otherwise would not

The price increase is tied directly to the low teaser monthly payment. Some of those initial teaser rates allowed the mortgage payment to be just slightly higher than what rents would be.

All shortsighted, of course. No one thought about when the rate adjusted, or cared. They were going to flip or take money out or whatever.

There will be more people in the rental market as they get evicted from their foreclosed homes. Therefore, the vacancies will be low. I think the rents will increase because of the mere demand. Predatory renting, so to speak. People will stretch their budget for a while. But ultimately, it can only go so high compared to incomes.

My two cents.

[jpinpb]

I would just like to add that it wasn’t merely the low interest rates which caused the housing price to increase. I believe it is the direct correlation between the low monthly payment on the teaser rate that allowed people to buy more expensive homes they otherwise would not

The price increase is tied directly to the low teaser monthly payment. Some of those initial teaser rates allowed the mortgage payment to be just slightly higher than what rents would be.

All shortsighted, of course. No one thought about when the rate adjusted, or cared. They were going to flip or take money out or whatever.

There will be more people in the rental market as they get evicted from their foreclosed homes. Therefore, the vacancies will be low. I think the rents will increase because of the mere demand. Predatory renting, so to speak. People will stretch their budget for a while. But ultimately, it can only go so high compared to incomes.

My two cents.

[jpinpb]

I would just like to add that it wasn’t merely the low interest rates which caused the housing price to increase. I believe it is the direct correlation between the low monthly payment on the teaser rate that allowed people to buy more expensive homes they otherwise would not

The price increase is tied directly to the low teaser monthly payment. Some of those initial teaser rates allowed the mortgage payment to be just slightly higher than what rents would be.

All shortsighted, of course. No one thought about when the rate adjusted, or cared. They were going to flip or take money out or whatever.

There will be more people in the rental market as they get evicted from their foreclosed homes. Therefore, the vacancies will be low. I think the rents will increase because of the mere demand. Predatory renting, so to speak. People will stretch their budget for a while. But ultimately, it can only go so high compared to incomes.

My two cents.

[jpinpb]

I would just like to add that it wasn’t merely the low interest rates which caused the housing price to increase. I believe it is the direct correlation between the low monthly payment on the teaser rate that allowed people to buy more expensive homes they otherwise would not

The price increase is tied directly to the low teaser monthly payment. Some of those initial teaser rates allowed the mortgage payment to be just slightly higher than what rents would be.

All shortsighted, of course. No one thought about when the rate adjusted, or cared. They were going to flip or take money out or whatever.

There will be more people in the rental market as they get evicted from their foreclosed homes. Therefore, the vacancies will be low. I think the rents will increase because of the mere demand. Predatory renting, so to speak. People will stretch their budget for a while. But ultimately, it can only go so high compared to incomes.

My two cents.

[gdcox]

Just a small point re ‘Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.’

You have to remember that in the 70s and 80s inflation was high. Even if house prices were stable in nominal terms they were going down fast in real terms .

Graham

[gdcox]

Just a small point re ‘Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.’

You have to remember that in the 70s and 80s inflation was high. Even if house prices were stable in nominal terms they were going down fast in real terms .

Graham

[gdcox]

Just a small point re ‘Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.’

You have to remember that in the 70s and 80s inflation was high. Even if house prices were stable in nominal terms they were going down fast in real terms .

Graham

[gdcox]

Just a small point re ‘Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.’

You have to remember that in the 70s and 80s inflation was high. Even if house prices were stable in nominal terms they were going down fast in real terms .

Graham

[gdcox]

Just a small point re ‘Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.’

You have to remember that in the 70s and 80s inflation was high. Even if house prices were stable in nominal terms they were going down fast in real terms .

Graham

[denverite]

gdox believes that the late 70’s had unusually high mortgage rates, and that this had the effect of reducing home prices ( and therefore, the income multiplier). At that time I lived in SD and sold some properties. It is true that properties took a while to move, but not true that housing prices declined to any significant extent. The reason: creative financing. If an owner actually wished to sell, they became the lender (at reasonable interest rates typically around 7-8 percent). There were many such alternatives promoted by the real estate industry to keep the cash flow going. “Creative Fincancing” was truly a huge buzzword at the time.

Banks and other traditional lenders were used only as a last resort, though it surely did happen.

Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.

My, albeit biased, conclusion is that the thrust of the article remains intact.

[denverite]

gdox believes that the late 70’s had unusually high mortgage rates, and that this had the effect of reducing home prices ( and therefore, the income multiplier). At that time I lived in SD and sold some properties. It is true that properties took a while to move, but not true that housing prices declined to any significant extent. The reason: creative financing. If an owner actually wished to sell, they became the lender (at reasonable interest rates typically around 7-8 percent). There were many such alternatives promoted by the real estate industry to keep the cash flow going. “Creative Fincancing” was truly a huge buzzword at the time.

Banks and other traditional lenders were used only as a last resort, though it surely did happen.

Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.

My, albeit biased, conclusion is that the thrust of the article remains intact.

[denverite]

gdox believes that the late 70’s had unusually high mortgage rates, and that this had the effect of reducing home prices ( and therefore, the income multiplier). At that time I lived in SD and sold some properties. It is true that properties took a while to move, but not true that housing prices declined to any significant extent. The reason: creative financing. If an owner actually wished to sell, they became the lender (at reasonable interest rates typically around 7-8 percent). There were many such alternatives promoted by the real estate industry to keep the cash flow going. “Creative Fincancing” was truly a huge buzzword at the time.

Banks and other traditional lenders were used only as a last resort, though it surely did happen.

Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.

My, albeit biased, conclusion is that the thrust of the article remains intact.

[denverite]

gdox believes that the late 70’s had unusually high mortgage rates, and that this had the effect of reducing home prices ( and therefore, the income multiplier). At that time I lived in SD and sold some properties. It is true that properties took a while to move, but not true that housing prices declined to any significant extent. The reason: creative financing. If an owner actually wished to sell, they became the lender (at reasonable interest rates typically around 7-8 percent). There were many such alternatives promoted by the real estate industry to keep the cash flow going. “Creative Fincancing” was truly a huge buzzword at the time.

Banks and other traditional lenders were used only as a last resort, though it surely did happen.

Also, one merely needs to look at historical price data (OFHEO) to understand that there was not a significant price decline at the time.

My, albeit biased, conclusion is that the thrust of the article remains intact.

[stansd]

Hi Rich,

I’ll take a crack conceptually-apologize for this being a bit of a stream of consciousness.

If we assume some sort of rational expectations, a house is like a dividend paying stock (the dividends being the right to live in the house, which has some value). The value of the house, then, would be equal to the present value of cash flows, which I’d say are equal to expected rents over the time horizon (owners equivalent, or something like that), plus the value of the house discounted to the present at the current interest rate over the horizon (10 yr t-bill or something).

On that side of the equation (ignoriing financing), then, lower interest rates should increase the present value of the house, but this effect would be muted by the following: lower interest rates would drive lower future rents (assuming those are based on an expected return from the owner), which would also be based on a spread over inflation.

I plugged this into a very simple model that assumed inflation and rent increases of 3%/year, a T-Bill Rate of 6%, and made the assumption that the spread over inflation on the T-Bill is constant at 3%.

Under this scenario, the rising value of the house from a lower interest rate is almost exactly offset by the fact that it slows down the rate of growth in rents, and therefore, the house wealth gained is also a benefit lost in the sense that you were saving less on the rent you would have paid.

That would be a simple, yet quantitative support for your argument, Rich (the result actually surprised me a bit).

You’d still have the financing side of the equation, but you don’t value stocks based on the method of financing, you value them purely on the cash flows of the stock. I’d argue you should do the same here-it’s the cash flows that you are buying that drive price, not the method of financing. The rate reductions are reflected already in the present values calculation on the house.

There are obviously other considerations: The option to refinance, the potential for spreads over treasuries to change, psychological changes in buyer preferences for owning vs. renting, the fact that emotion can enter the market and that not all participants are acting rationally, etc. The recent bubble bears this out since the above would indicate that the abnormally low rates wouldn’t be a boon for prices-I’d argue that was psychology, not economics driven and that the economics can only explain the long-term gravitational pull toward a rational value

That’s a stab:

Stan

[patientlywaiting]

Rich and Stan. Interesting write up. Thanks for sharing. I enjoyed reading.

[drunkle]

what about the downpayment aspect of home pricing? that is, with no downpayment, you could afford to pay the same to own as you pay in rent. that being the primary reason under “normal” 20% down scenario that people still rent even if the monthly cost is the same as buy. they just dont have the down, can’t save the down and when they try, when the economy is doing well and they can afford to save, so can everyone else…

edit:

and with regards to stocks and bonds, what are the normal barriers to investing? ie., prior to etrade and 401k’s, wasn’t a minimum investment of some significant size required? even opening a cd requires a deposit larger than most people (j6p) are able or willing to drop…

[drunkle]

what about the downpayment aspect of home pricing? that is, with no downpayment, you could afford to pay the same to own as you pay in rent. that being the primary reason under “normal” 20% down scenario that people still rent even if the monthly cost is the same as buy. they just dont have the down, can’t save the down and when they try, when the economy is doing well and they can afford to save, so can everyone else…

edit:

and with regards to stocks and bonds, what are the normal barriers to investing? ie., prior to etrade and 401k’s, wasn’t a minimum investment of some significant size required? even opening a cd requires a deposit larger than most people (j6p) are able or willing to drop…

[drunkle]

what about the downpayment aspect of home pricing? that is, with no downpayment, you could afford to pay the same to own as you pay in rent. that being the primary reason under “normal” 20% down scenario that people still rent even if the monthly cost is the same as buy. they just dont have the down, can’t save the down and when they try, when the economy is doing well and they can afford to save, so can everyone else…

edit:

and with regards to stocks and bonds, what are the normal barriers to investing? ie., prior to etrade and 401k’s, wasn’t a minimum investment of some significant size required? even opening a cd requires a deposit larger than most people (j6p) are able or willing to drop…

[drunkle]

what about the downpayment aspect of home pricing? that is, with no downpayment, you could afford to pay the same to own as you pay in rent. that being the primary reason under “normal” 20% down scenario that people still rent even if the monthly cost is the same as buy. they just dont have the down, can’t save the down and when they try, when the economy is doing well and they can afford to save, so can everyone else…

edit:

and with regards to stocks and bonds, what are the normal barriers to investing? ie., prior to etrade and 401k’s, wasn’t a minimum investment of some significant size required? even opening a cd requires a deposit larger than most people (j6p) are able or willing to drop…

[drunkle]

what about the downpayment aspect of home pricing? that is, with no downpayment, you could afford to pay the same to own as you pay in rent. that being the primary reason under “normal” 20% down scenario that people still rent even if the monthly cost is the same as buy. they just dont have the down, can’t save the down and when they try, when the economy is doing well and they can afford to save, so can everyone else…

edit:

and with regards to stocks and bonds, what are the normal barriers to investing? ie., prior to etrade and 401k’s, wasn’t a minimum investment of some significant size required? even opening a cd requires a deposit larger than most people (j6p) are able or willing to drop…

[gdcox]

Great contributions from everyone….all of us trying to put in 2D text what should be in a multi-factor model of great complexity (and in fact impossible to build).

One analytical method that must now be deemed impossible is any kind of model for mortgage supply and demand (which feeds into the house price model). The impact of structural change in the supply of mortgages and their types has been so extreme in the last five to ten years (of which the arrival of ARMs in their various guises is only one of many factors) that no sensible time series could be constructed now in my view. The chaotic effect of the current credit crisis (and legislative reactions as well) will just muddy the regression waters some more.

That is partly why I instinctively favor looking at the rental/buy decision and landlord investment buy/sell decision in simple terms to try to feel for inflexion points in the residential real estate market.

As various contributors have pointed out , we cannot be sure what rent levels will be. Rents should rise with repos (as happened in the mid 80s) varying by area as well, but a recession would tend to restrain growth of income and hence rents as has been pointed out . Hope people feed back on the rental market over time .

Graham

[jpinpb]

Eventually those bank owned homes will sell and back in use by someone who won’t be renting. Ease the rental market strain.

Seems there is some correlation also between the builders cutting back on future building, causing concern of decrease of homes. However, with the continued tightening of credit standards, that decreases the buyers.

I’m personally amused by the incentives of builders, upgrades, etc. Really, the only thing that will sell is drastic reduction in price. DR Horton seems to have figured that out. Maybe some others will follow suit.

[jpinpb]

Eventually those bank owned homes will sell and back in use by someone who won’t be renting. Ease the rental market strain.

Seems there is some correlation also between the builders cutting back on future building, causing concern of decrease of homes. However, with the continued tightening of credit standards, that decreases the buyers.

I’m personally amused by the incentives of builders, upgrades, etc. Really, the only thing that will sell is drastic reduction in price. DR Horton seems to have figured that out. Maybe some others will follow suit.

[jpinpb]

Eventually those bank owned homes will sell and back in use by someone who won’t be renting. Ease the rental market strain.

Seems there is some correlation also between the builders cutting back on future building, causing concern of decrease of homes. However, with the continued tightening of credit standards, that decreases the buyers.

I’m personally amused by the incentives of builders, upgrades, etc. Really, the only thing that will sell is drastic reduction in price. DR Horton seems to have figured that out. Maybe some others will follow suit.

[jpinpb]

Eventually those bank owned homes will sell and back in use by someone who won’t be renting. Ease the rental market strain.

Seems there is some correlation also between the builders cutting back on future building, causing concern of decrease of homes. However, with the continued tightening of credit standards, that decreases the buyers.

I’m personally amused by the incentives of builders, upgrades, etc. Really, the only thing that will sell is drastic reduction in price. DR Horton seems to have figured that out. Maybe some others will follow suit.

[jpinpb]

Eventually those bank owned homes will sell and back in use by someone who won’t be renting. Ease the rental market strain.

Seems there is some correlation also between the builders cutting back on future building, causing concern of decrease of homes. However, with the continued tightening of credit standards, that decreases the buyers.

I’m personally amused by the incentives of builders, upgrades, etc. Really, the only thing that will sell is drastic reduction in price. DR Horton seems to have figured that out. Maybe some others will follow suit.

[(former)FormerSanDiegan]

gdcox wrote : As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse.

I have to agree 100% with gdcox with respect to these statements. By using current rents and current carrying costs you don’t have to worry about all the academic issues about whether higher interest rates or inflation were a factor or not in impacting historical price to income ratios. Those metrics are excellent for point out the bubble and tracking historical changes. BUT, the ultimate fundamental in my opinion is how rents relate to carrying costs on a property. If you look at prices, rents and carrying costs as an ongoing business concern, it is insightful.

SFRs in central San Diego currently rent for about 7% of the property value. If property values drop by 30% you are looking at 10% gross. If they dropped by 60% you’d be looking at 17.5 % gross.
Somewhere in there prices, rents and interest rates will result in situations where it makes sense as a business to own property.

This calculation depends on prevailing rates on alternative investments, mortgage rates/availability, rents, and home prices.

My guess is that we will see these things line up to make owning property as a business at price points no lower than about 15% below current prices. Rents dropping more than a few percent and/or interest rates going above 7-8% would change this.

[(former)FormerSanDiegan]

gdcox wrote : As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse.

I have to agree 100% with gdcox with respect to these statements. By using current rents and current carrying costs you don’t have to worry about all the academic issues about whether higher interest rates or inflation were a factor or not in impacting historical price to income ratios. Those metrics are excellent for point out the bubble and tracking historical changes. BUT, the ultimate fundamental in my opinion is how rents relate to carrying costs on a property. If you look at prices, rents and carrying costs as an ongoing business concern, it is insightful.

SFRs in central San Diego currently rent for about 7% of the property value. If property values drop by 30% you are looking at 10% gross. If they dropped by 60% you’d be looking at 17.5 % gross.
Somewhere in there prices, rents and interest rates will result in situations where it makes sense as a business to own property.

This calculation depends on prevailing rates on alternative investments, mortgage rates/availability, rents, and home prices.

My guess is that we will see these things line up to make owning property as a business at price points no lower than about 15% below current prices. Rents dropping more than a few percent and/or interest rates going above 7-8% would change this.

[(former)FormerSanDiegan]

gdcox wrote : As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse.

I have to agree 100% with gdcox with respect to these statements. By using current rents and current carrying costs you don’t have to worry about all the academic issues about whether higher interest rates or inflation were a factor or not in impacting historical price to income ratios. Those metrics are excellent for point out the bubble and tracking historical changes. BUT, the ultimate fundamental in my opinion is how rents relate to carrying costs on a property. If you look at prices, rents and carrying costs as an ongoing business concern, it is insightful.

SFRs in central San Diego currently rent for about 7% of the property value. If property values drop by 30% you are looking at 10% gross. If they dropped by 60% you’d be looking at 17.5 % gross.
Somewhere in there prices, rents and interest rates will result in situations where it makes sense as a business to own property.

This calculation depends on prevailing rates on alternative investments, mortgage rates/availability, rents, and home prices.

My guess is that we will see these things line up to make owning property as a business at price points no lower than about 15% below current prices. Rents dropping more than a few percent and/or interest rates going above 7-8% would change this.

[(former)FormerSanDiegan]

gdcox wrote : As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse.

I have to agree 100% with gdcox with respect to these statements. By using current rents and current carrying costs you don’t have to worry about all the academic issues about whether higher interest rates or inflation were a factor or not in impacting historical price to income ratios. Those metrics are excellent for point out the bubble and tracking historical changes. BUT, the ultimate fundamental in my opinion is how rents relate to carrying costs on a property. If you look at prices, rents and carrying costs as an ongoing business concern, it is insightful.

SFRs in central San Diego currently rent for about 7% of the property value. If property values drop by 30% you are looking at 10% gross. If they dropped by 60% you’d be looking at 17.5 % gross.
Somewhere in there prices, rents and interest rates will result in situations where it makes sense as a business to own property.

This calculation depends on prevailing rates on alternative investments, mortgage rates/availability, rents, and home prices.

My guess is that we will see these things line up to make owning property as a business at price points no lower than about 15% below current prices. Rents dropping more than a few percent and/or interest rates going above 7-8% would change this.

[(former)FormerSanDiegan]

gdcox wrote : As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse.

I have to agree 100% with gdcox with respect to these statements. By using current rents and current carrying costs you don’t have to worry about all the academic issues about whether higher interest rates or inflation were a factor or not in impacting historical price to income ratios. Those metrics are excellent for point out the bubble and tracking historical changes. BUT, the ultimate fundamental in my opinion is how rents relate to carrying costs on a property. If you look at prices, rents and carrying costs as an ongoing business concern, it is insightful.

SFRs in central San Diego currently rent for about 7% of the property value. If property values drop by 30% you are looking at 10% gross. If they dropped by 60% you’d be looking at 17.5 % gross.
Somewhere in there prices, rents and interest rates will result in situations where it makes sense as a business to own property.

This calculation depends on prevailing rates on alternative investments, mortgage rates/availability, rents, and home prices.

My guess is that we will see these things line up to make owning property as a business at price points no lower than about 15% below current prices. Rents dropping more than a few percent and/or interest rates going above 7-8% would change this.

[gdcox]

Great contributions from everyone….all of us trying to put in 2D text what should be in a multi-factor model of great complexity (and in fact impossible to build).

One analytical method that must now be deemed impossible is any kind of model for mortgage supply and demand (which feeds into the house price model). The impact of structural change in the supply of mortgages and their types has been so extreme in the last five to ten years (of which the arrival of ARMs in their various guises is only one of many factors) that no sensible time series could be constructed now in my view. The chaotic effect of the current credit crisis (and legislative reactions as well) will just muddy the regression waters some more.

That is partly why I instinctively favor looking at the rental/buy decision and landlord investment buy/sell decision in simple terms to try to feel for inflexion points in the residential real estate market.

As various contributors have pointed out , we cannot be sure what rent levels will be. Rents should rise with repos (as happened in the mid 80s) varying by area as well, but a recession would tend to restrain growth of income and hence rents as has been pointed out . Hope people feed back on the rental market over time .

Graham

[gdcox]

Great contributions from everyone….all of us trying to put in 2D text what should be in a multi-factor model of great complexity (and in fact impossible to build).

One analytical method that must now be deemed impossible is any kind of model for mortgage supply and demand (which feeds into the house price model). The impact of structural change in the supply of mortgages and their types has been so extreme in the last five to ten years (of which the arrival of ARMs in their various guises is only one of many factors) that no sensible time series could be constructed now in my view. The chaotic effect of the current credit crisis (and legislative reactions as well) will just muddy the regression waters some more.

That is partly why I instinctively favor looking at the rental/buy decision and landlord investment buy/sell decision in simple terms to try to feel for inflexion points in the residential real estate market.

As various contributors have pointed out , we cannot be sure what rent levels will be. Rents should rise with repos (as happened in the mid 80s) varying by area as well, but a recession would tend to restrain growth of income and hence rents as has been pointed out . Hope people feed back on the rental market over time .

Graham

[gdcox]

Great contributions from everyone….all of us trying to put in 2D text what should be in a multi-factor model of great complexity (and in fact impossible to build).

One analytical method that must now be deemed impossible is any kind of model for mortgage supply and demand (which feeds into the house price model). The impact of structural change in the supply of mortgages and their types has been so extreme in the last five to ten years (of which the arrival of ARMs in their various guises is only one of many factors) that no sensible time series could be constructed now in my view. The chaotic effect of the current credit crisis (and legislative reactions as well) will just muddy the regression waters some more.

That is partly why I instinctively favor looking at the rental/buy decision and landlord investment buy/sell decision in simple terms to try to feel for inflexion points in the residential real estate market.

As various contributors have pointed out , we cannot be sure what rent levels will be. Rents should rise with repos (as happened in the mid 80s) varying by area as well, but a recession would tend to restrain growth of income and hence rents as has been pointed out . Hope people feed back on the rental market over time .

Graham

[gdcox]

Great contributions from everyone….all of us trying to put in 2D text what should be in a multi-factor model of great complexity (and in fact impossible to build).

One analytical method that must now be deemed impossible is any kind of model for mortgage supply and demand (which feeds into the house price model). The impact of structural change in the supply of mortgages and their types has been so extreme in the last five to ten years (of which the arrival of ARMs in their various guises is only one of many factors) that no sensible time series could be constructed now in my view. The chaotic effect of the current credit crisis (and legislative reactions as well) will just muddy the regression waters some more.

That is partly why I instinctively favor looking at the rental/buy decision and landlord investment buy/sell decision in simple terms to try to feel for inflexion points in the residential real estate market.

As various contributors have pointed out , we cannot be sure what rent levels will be. Rents should rise with repos (as happened in the mid 80s) varying by area as well, but a recession would tend to restrain growth of income and hence rents as has been pointed out . Hope people feed back on the rental market over time .

Graham

[patientlywaiting]

Rich and Stan. Interesting write up. Thanks for sharing. I enjoyed reading.

[patientlywaiting]

Rich and Stan. Interesting write up. Thanks for sharing. I enjoyed reading.

[patientlywaiting]

Rich and Stan. Interesting write up. Thanks for sharing. I enjoyed reading.

[patientlywaiting]

Rich and Stan. Interesting write up. Thanks for sharing. I enjoyed reading.

[Rich Toscano]

Hi Stan – Great point about rents. I would also add another point if you are assuming static rates and inflation: if rates and inflation can both be assumed to be low, the “real” burden of your debt will stay higher through the amortization. In contrast, if rates/inflation are high, you are paying more interest, but you are basically paying off your mortgage faster as inflation eats away at the real burden of your principal.

But, what I was more attempting to get at was the fact that rates and inflation are NOT static. So discounting future income using today’s 10-year Treasury doesn’t really take that into account, if I am understanding you correctly.

And again, I’m kind of muddying the waters here by trying to figure out not one guy’s decision to buy or not, but rather what represents a fundamentally justifiable, sustainable level of pricing. For this latter, it seems to me that one must take the long view on rates. Or, that one should ignore rates altogether, because A) they haven’t had much impact historically and B) since their future direction is unknown, they shouldn’t figure into pricing. Or something.

I’m pretty exhausted and out of it this evening so the above may or may not make sense. Thanks for sharing your insights.

Rich

PS – Ray – In bonds, you care not just about the current rate but about future rates. I’m arguing that the same is true in housing.

[Rich Toscano]

Hi Stan – Great point about rents. I would also add another point if you are assuming static rates and inflation: if rates and inflation can both be assumed to be low, the “real” burden of your debt will stay higher through the amortization. In contrast, if rates/inflation are high, you are paying more interest, but you are basically paying off your mortgage faster as inflation eats away at the real burden of your principal.

But, what I was more attempting to get at was the fact that rates and inflation are NOT static. So discounting future income using today’s 10-year Treasury doesn’t really take that into account, if I am understanding you correctly.

And again, I’m kind of muddying the waters here by trying to figure out not one guy’s decision to buy or not, but rather what represents a fundamentally justifiable, sustainable level of pricing. For this latter, it seems to me that one must take the long view on rates. Or, that one should ignore rates altogether, because A) they haven’t had much impact historically and B) since their future direction is unknown, they shouldn’t figure into pricing. Or something.

I’m pretty exhausted and out of it this evening so the above may or may not make sense. Thanks for sharing your insights.

Rich

PS – Ray – In bonds, you care not just about the current rate but about future rates. I’m arguing that the same is true in housing.

[Rich Toscano]

Hi Stan – Great point about rents. I would also add another point if you are assuming static rates and inflation: if rates and inflation can both be assumed to be low, the “real” burden of your debt will stay higher through the amortization. In contrast, if rates/inflation are high, you are paying more interest, but you are basically paying off your mortgage faster as inflation eats away at the real burden of your principal.

But, what I was more attempting to get at was the fact that rates and inflation are NOT static. So discounting future income using today’s 10-year Treasury doesn’t really take that into account, if I am understanding you correctly.

And again, I’m kind of muddying the waters here by trying to figure out not one guy’s decision to buy or not, but rather what represents a fundamentally justifiable, sustainable level of pricing. For this latter, it seems to me that one must take the long view on rates. Or, that one should ignore rates altogether, because A) they haven’t had much impact historically and B) since their future direction is unknown, they shouldn’t figure into pricing. Or something.

I’m pretty exhausted and out of it this evening so the above may or may not make sense. Thanks for sharing your insights.

Rich

PS – Ray – In bonds, you care not just about the current rate but about future rates. I’m arguing that the same is true in housing.

[Rich Toscano]

Hi Stan – Great point about rents. I would also add another point if you are assuming static rates and inflation: if rates and inflation can both be assumed to be low, the “real” burden of your debt will stay higher through the amortization. In contrast, if rates/inflation are high, you are paying more interest, but you are basically paying off your mortgage faster as inflation eats away at the real burden of your principal.

But, what I was more attempting to get at was the fact that rates and inflation are NOT static. So discounting future income using today’s 10-year Treasury doesn’t really take that into account, if I am understanding you correctly.

And again, I’m kind of muddying the waters here by trying to figure out not one guy’s decision to buy or not, but rather what represents a fundamentally justifiable, sustainable level of pricing. For this latter, it seems to me that one must take the long view on rates. Or, that one should ignore rates altogether, because A) they haven’t had much impact historically and B) since their future direction is unknown, they shouldn’t figure into pricing. Or something.

I’m pretty exhausted and out of it this evening so the above may or may not make sense. Thanks for sharing your insights.

Rich

PS – Ray – In bonds, you care not just about the current rate but about future rates. I’m arguing that the same is true in housing.

[Rich Toscano]

Hi Stan – Great point about rents. I would also add another point if you are assuming static rates and inflation: if rates and inflation can both be assumed to be low, the “real” burden of your debt will stay higher through the amortization. In contrast, if rates/inflation are high, you are paying more interest, but you are basically paying off your mortgage faster as inflation eats away at the real burden of your principal.

But, what I was more attempting to get at was the fact that rates and inflation are NOT static. So discounting future income using today’s 10-year Treasury doesn’t really take that into account, if I am understanding you correctly.

And again, I’m kind of muddying the waters here by trying to figure out not one guy’s decision to buy or not, but rather what represents a fundamentally justifiable, sustainable level of pricing. For this latter, it seems to me that one must take the long view on rates. Or, that one should ignore rates altogether, because A) they haven’t had much impact historically and B) since their future direction is unknown, they shouldn’t figure into pricing. Or something.

I’m pretty exhausted and out of it this evening so the above may or may not make sense. Thanks for sharing your insights.

Rich

PS – Ray – In bonds, you care not just about the current rate but about future rates. I’m arguing that the same is true in housing.

[stansd]

Hi Rich,

I’ll take a crack conceptually-apologize for this being a bit of a stream of consciousness.

If we assume some sort of rational expectations, a house is like a dividend paying stock (the dividends being the right to live in the house, which has some value). The value of the house, then, would be equal to the present value of cash flows, which I’d say are equal to expected rents over the time horizon (owners equivalent, or something like that), plus the value of the house discounted to the present at the current interest rate over the horizon (10 yr t-bill or something).

On that side of the equation (ignoriing financing), then, lower interest rates should increase the present value of the house, but this effect would be muted by the following: lower interest rates would drive lower future rents (assuming those are based on an expected return from the owner), which would also be based on a spread over inflation.

I plugged this into a very simple model that assumed inflation and rent increases of 3%/year, a T-Bill Rate of 6%, and made the assumption that the spread over inflation on the T-Bill is constant at 3%.

Under this scenario, the rising value of the house from a lower interest rate is almost exactly offset by the fact that it slows down the rate of growth in rents, and therefore, the house wealth gained is also a benefit lost in the sense that you were saving less on the rent you would have paid.

That would be a simple, yet quantitative support for your argument, Rich (the result actually surprised me a bit).

You’d still have the financing side of the equation, but you don’t value stocks based on the method of financing, you value them purely on the cash flows of the stock. I’d argue you should do the same here-it’s the cash flows that you are buying that drive price, not the method of financing. The rate reductions are reflected already in the present values calculation on the house.

There are obviously other considerations: The option to refinance, the potential for spreads over treasuries to change, psychological changes in buyer preferences for owning vs. renting, the fact that emotion can enter the market and that not all participants are acting rationally, etc. The recent bubble bears this out since the above would indicate that the abnormally low rates wouldn’t be a boon for prices-I’d argue that was psychology, not economics driven and that the economics can only explain the long-term gravitational pull toward a rational value

That’s a stab:

Stan

[stansd]

Hi Rich,

I’ll take a crack conceptually-apologize for this being a bit of a stream of consciousness.

If we assume some sort of rational expectations, a house is like a dividend paying stock (the dividends being the right to live in the house, which has some value). The value of the house, then, would be equal to the present value of cash flows, which I’d say are equal to expected rents over the time horizon (owners equivalent, or something like that), plus the value of the house discounted to the present at the current interest rate over the horizon (10 yr t-bill or something).

On that side of the equation (ignoriing financing), then, lower interest rates should increase the present value of the house, but this effect would be muted by the following: lower interest rates would drive lower future rents (assuming those are based on an expected return from the owner), which would also be based on a spread over inflation.

I plugged this into a very simple model that assumed inflation and rent increases of 3%/year, a T-Bill Rate of 6%, and made the assumption that the spread over inflation on the T-Bill is constant at 3%.

Under this scenario, the rising value of the house from a lower interest rate is almost exactly offset by the fact that it slows down the rate of growth in rents, and therefore, the house wealth gained is also a benefit lost in the sense that you were saving less on the rent you would have paid.

That would be a simple, yet quantitative support for your argument, Rich (the result actually surprised me a bit).

You’d still have the financing side of the equation, but you don’t value stocks based on the method of financing, you value them purely on the cash flows of the stock. I’d argue you should do the same here-it’s the cash flows that you are buying that drive price, not the method of financing. The rate reductions are reflected already in the present values calculation on the house.

There are obviously other considerations: The option to refinance, the potential for spreads over treasuries to change, psychological changes in buyer preferences for owning vs. renting, the fact that emotion can enter the market and that not all participants are acting rationally, etc. The recent bubble bears this out since the above would indicate that the abnormally low rates wouldn’t be a boon for prices-I’d argue that was psychology, not economics driven and that the economics can only explain the long-term gravitational pull toward a rational value

That’s a stab:

Stan

[stansd]

Hi Rich,

I’ll take a crack conceptually-apologize for this being a bit of a stream of consciousness.

If we assume some sort of rational expectations, a house is like a dividend paying stock (the dividends being the right to live in the house, which has some value). The value of the house, then, would be equal to the present value of cash flows, which I’d say are equal to expected rents over the time horizon (owners equivalent, or something like that), plus the value of the house discounted to the present at the current interest rate over the horizon (10 yr t-bill or something).

On that side of the equation (ignoriing financing), then, lower interest rates should increase the present value of the house, but this effect would be muted by the following: lower interest rates would drive lower future rents (assuming those are based on an expected return from the owner), which would also be based on a spread over inflation.

I plugged this into a very simple model that assumed inflation and rent increases of 3%/year, a T-Bill Rate of 6%, and made the assumption that the spread over inflation on the T-Bill is constant at 3%.

Under this scenario, the rising value of the house from a lower interest rate is almost exactly offset by the fact that it slows down the rate of growth in rents, and therefore, the house wealth gained is also a benefit lost in the sense that you were saving less on the rent you would have paid.

That would be a simple, yet quantitative support for your argument, Rich (the result actually surprised me a bit).

You’d still have the financing side of the equation, but you don’t value stocks based on the method of financing, you value them purely on the cash flows of the stock. I’d argue you should do the same here-it’s the cash flows that you are buying that drive price, not the method of financing. The rate reductions are reflected already in the present values calculation on the house.

There are obviously other considerations: The option to refinance, the potential for spreads over treasuries to change, psychological changes in buyer preferences for owning vs. renting, the fact that emotion can enter the market and that not all participants are acting rationally, etc. The recent bubble bears this out since the above would indicate that the abnormally low rates wouldn’t be a boon for prices-I’d argue that was psychology, not economics driven and that the economics can only explain the long-term gravitational pull toward a rational value

That’s a stab:

Stan

[stansd]

Hi Rich,

I’ll take a crack conceptually-apologize for this being a bit of a stream of consciousness.

If we assume some sort of rational expectations, a house is like a dividend paying stock (the dividends being the right to live in the house, which has some value). The value of the house, then, would be equal to the present value of cash flows, which I’d say are equal to expected rents over the time horizon (owners equivalent, or something like that), plus the value of the house discounted to the present at the current interest rate over the horizon (10 yr t-bill or something).

On that side of the equation (ignoriing financing), then, lower interest rates should increase the present value of the house, but this effect would be muted by the following: lower interest rates would drive lower future rents (assuming those are based on an expected return from the owner), which would also be based on a spread over inflation.

I plugged this into a very simple model that assumed inflation and rent increases of 3%/year, a T-Bill Rate of 6%, and made the assumption that the spread over inflation on the T-Bill is constant at 3%.

Under this scenario, the rising value of the house from a lower interest rate is almost exactly offset by the fact that it slows down the rate of growth in rents, and therefore, the house wealth gained is also a benefit lost in the sense that you were saving less on the rent you would have paid.

That would be a simple, yet quantitative support for your argument, Rich (the result actually surprised me a bit).

You’d still have the financing side of the equation, but you don’t value stocks based on the method of financing, you value them purely on the cash flows of the stock. I’d argue you should do the same here-it’s the cash flows that you are buying that drive price, not the method of financing. The rate reductions are reflected already in the present values calculation on the house.

There are obviously other considerations: The option to refinance, the potential for spreads over treasuries to change, psychological changes in buyer preferences for owning vs. renting, the fact that emotion can enter the market and that not all participants are acting rationally, etc. The recent bubble bears this out since the above would indicate that the abnormally low rates wouldn’t be a boon for prices-I’d argue that was psychology, not economics driven and that the economics can only explain the long-term gravitational pull toward a rational value

That’s a stab:

Stan

[Rich Toscano]

I am very skeptical of the idea that lower interest rates justify higher home prices. Let me throw a couple of thoughts out there haphazardly — this is an article I’ve wanted to write for a while so this is a good opportunity to get feedback on my thinking.

1 – The historical record doesn’t support it

Check out this graph: http://piggington.com/images/primer/sdpricetoincome.gif The p/i ratio peaked and trough at the same place in the prior two cycles, despite vast differences in rates. This time around, the difference was not rates but incredibly (and unsustainably) loose underwriting due to the securitization boom.

Also I did a quick regression and there was no correlation between rates and inflation-adjusted home prices from 77-2000. If you include the latest bubble there was a mild positive correlation but again, i think that’s due to underwriting. Not sure how to prove that thesis, except for the fact that falling yields never before affected the p/i ratio, so it must be something else.

BTW rates fell thru both of the prior downturns — http://piggington.com/historical_home_prices_payments_rents_rates — how does that fit in?

2 – Houses are long-duration assets, or something

This is the part I’ve had trouble describing coherently. For the individual making a rent/buy decision, lower rates are definitely a consideration (as long as you will be in the house for long enough to reap the benefits of locking in a low rate. There’s always the argument that you can refi in the future, but what if rates only go up from here?).

However, think about the market as a whole and future rate/price direction. If rates rise, they will put downward pressure on prices (maybe? see above – but let’s say they do) in the future. Given that rates are low, and in specific that real yields are unusually low, there is a good chance of rates rising — shouldn’t this future pressure be priced into the justifiable home price?

Or let me try to explain it a different way. When you buy a house, the future value of that house will be influenced by FUTURE rates, not just current rates. So just because rates have spiked down, does that suddenly argue that prices should be higher? I’d argue not.

Or a third angle: the “justifiable” price may be influenced by rates, but it has to be influenced by the average level of rates over the holding period of the home, not just rates right now. Hmm, I think that may be a better way to describe it.

You can see why I haven’t written about this yet. 🙂 The concept is clear in my mind but I don’t know how to explain it. Thoughts?

Rich

[Rich Toscano]

I am very skeptical of the idea that lower interest rates justify higher home prices. Let me throw a couple of thoughts out there haphazardly — this is an article I’ve wanted to write for a while so this is a good opportunity to get feedback on my thinking.

1 – The historical record doesn’t support it

Check out this graph: http://piggington.com/images/primer/sdpricetoincome.gif The p/i ratio peaked and trough at the same place in the prior two cycles, despite vast differences in rates. This time around, the difference was not rates but incredibly (and unsustainably) loose underwriting due to the securitization boom.

Also I did a quick regression and there was no correlation between rates and inflation-adjusted home prices from 77-2000. If you include the latest bubble there was a mild positive correlation but again, i think that’s due to underwriting. Not sure how to prove that thesis, except for the fact that falling yields never before affected the p/i ratio, so it must be something else.

BTW rates fell thru both of the prior downturns — http://piggington.com/historical_home_prices_payments_rents_rates — how does that fit in?

2 – Houses are long-duration assets, or something

This is the part I’ve had trouble describing coherently. For the individual making a rent/buy decision, lower rates are definitely a consideration (as long as you will be in the house for long enough to reap the benefits of locking in a low rate. There’s always the argument that you can refi in the future, but what if rates only go up from here?).

However, think about the market as a whole and future rate/price direction. If rates rise, they will put downward pressure on prices (maybe? see above – but let’s say they do) in the future. Given that rates are low, and in specific that real yields are unusually low, there is a good chance of rates rising — shouldn’t this future pressure be priced into the justifiable home price?

Or let me try to explain it a different way. When you buy a house, the future value of that house will be influenced by FUTURE rates, not just current rates. So just because rates have spiked down, does that suddenly argue that prices should be higher? I’d argue not.

Or a third angle: the “justifiable” price may be influenced by rates, but it has to be influenced by the average level of rates over the holding period of the home, not just rates right now. Hmm, I think that may be a better way to describe it.

You can see why I haven’t written about this yet. 🙂 The concept is clear in my mind but I don’t know how to explain it. Thoughts?

Rich

[Rich Toscano]

I am very skeptical of the idea that lower interest rates justify higher home prices. Let me throw a couple of thoughts out there haphazardly — this is an article I’ve wanted to write for a while so this is a good opportunity to get feedback on my thinking.

1 – The historical record doesn’t support it

Check out this graph: http://piggington.com/images/primer/sdpricetoincome.gif The p/i ratio peaked and trough at the same place in the prior two cycles, despite vast differences in rates. This time around, the difference was not rates but incredibly (and unsustainably) loose underwriting due to the securitization boom.

Also I did a quick regression and there was no correlation between rates and inflation-adjusted home prices from 77-2000. If you include the latest bubble there was a mild positive correlation but again, i think that’s due to underwriting. Not sure how to prove that thesis, except for the fact that falling yields never before affected the p/i ratio, so it must be something else.

BTW rates fell thru both of the prior downturns — http://piggington.com/historical_home_prices_payments_rents_rates — how does that fit in?

2 – Houses are long-duration assets, or something

This is the part I’ve had trouble describing coherently. For the individual making a rent/buy decision, lower rates are definitely a consideration (as long as you will be in the house for long enough to reap the benefits of locking in a low rate. There’s always the argument that you can refi in the future, but what if rates only go up from here?).

However, think about the market as a whole and future rate/price direction. If rates rise, they will put downward pressure on prices (maybe? see above – but let’s say they do) in the future. Given that rates are low, and in specific that real yields are unusually low, there is a good chance of rates rising — shouldn’t this future pressure be priced into the justifiable home price?

Or let me try to explain it a different way. When you buy a house, the future value of that house will be influenced by FUTURE rates, not just current rates. So just because rates have spiked down, does that suddenly argue that prices should be higher? I’d argue not.

Or a third angle: the “justifiable” price may be influenced by rates, but it has to be influenced by the average level of rates over the holding period of the home, not just rates right now. Hmm, I think that may be a better way to describe it.

You can see why I haven’t written about this yet. 🙂 The concept is clear in my mind but I don’t know how to explain it. Thoughts?

Rich

[Rich Toscano]

I am very skeptical of the idea that lower interest rates justify higher home prices. Let me throw a couple of thoughts out there haphazardly — this is an article I’ve wanted to write for a while so this is a good opportunity to get feedback on my thinking.

1 – The historical record doesn’t support it

Check out this graph: http://piggington.com/images/primer/sdpricetoincome.gif The p/i ratio peaked and trough at the same place in the prior two cycles, despite vast differences in rates. This time around, the difference was not rates but incredibly (and unsustainably) loose underwriting due to the securitization boom.

Also I did a quick regression and there was no correlation between rates and inflation-adjusted home prices from 77-2000. If you include the latest bubble there was a mild positive correlation but again, i think that’s due to underwriting. Not sure how to prove that thesis, except for the fact that falling yields never before affected the p/i ratio, so it must be something else.

BTW rates fell thru both of the prior downturns — http://piggington.com/historical_home_prices_payments_rents_rates — how does that fit in?

2 – Houses are long-duration assets, or something

This is the part I’ve had trouble describing coherently. For the individual making a rent/buy decision, lower rates are definitely a consideration (as long as you will be in the house for long enough to reap the benefits of locking in a low rate. There’s always the argument that you can refi in the future, but what if rates only go up from here?).

However, think about the market as a whole and future rate/price direction. If rates rise, they will put downward pressure on prices (maybe? see above – but let’s say they do) in the future. Given that rates are low, and in specific that real yields are unusually low, there is a good chance of rates rising — shouldn’t this future pressure be priced into the justifiable home price?

Or let me try to explain it a different way. When you buy a house, the future value of that house will be influenced by FUTURE rates, not just current rates. So just because rates have spiked down, does that suddenly argue that prices should be higher? I’d argue not.

Or a third angle: the “justifiable” price may be influenced by rates, but it has to be influenced by the average level of rates over the holding period of the home, not just rates right now. Hmm, I think that may be a better way to describe it.

You can see why I haven’t written about this yet. 🙂 The concept is clear in my mind but I don’t know how to explain it. Thoughts?

Rich

[cr]

Good points GD, and agreed Bugs. BobS, your point is good too, but payments can be mis-leading depending on the type of loan.

Rents cannot rise beyond incomes either. Rents may increase as the bubble deflates and could potentially lessen price declines, but both are ruled by income.

If incomes (stagnate at best, not to mention rising unemployment i.e. fewer people with those incomes) don’t keep up with the cost of either then both are overinflated. I can see how rents and prices could stay high for a while in a transitional period, and diminish in appearance the size of the bubble, but I don’t see how both can stay unaffordably high long enough for incomes to catch up. The same reason people are losing their homes will mean they eventaully can’t afford higher rents. Going into a housing-induced recession will eventually lead to a deeper drop in rents and prices, until incomes catch up. And if the past 2 bubbles are any indication, there will be an over-correction.

I think we will start to see people move away in droves from these high cost markets.

[cr]

Good points GD, and agreed Bugs. BobS, your point is good too, but payments can be mis-leading depending on the type of loan.

Rents cannot rise beyond incomes either. Rents may increase as the bubble deflates and could potentially lessen price declines, but both are ruled by income.

If incomes (stagnate at best, not to mention rising unemployment i.e. fewer people with those incomes) don’t keep up with the cost of either then both are overinflated. I can see how rents and prices could stay high for a while in a transitional period, and diminish in appearance the size of the bubble, but I don’t see how both can stay unaffordably high long enough for incomes to catch up. The same reason people are losing their homes will mean they eventaully can’t afford higher rents. Going into a housing-induced recession will eventually lead to a deeper drop in rents and prices, until incomes catch up. And if the past 2 bubbles are any indication, there will be an over-correction.

I think we will start to see people move away in droves from these high cost markets.

[cr]

Good points GD, and agreed Bugs. BobS, your point is good too, but payments can be mis-leading depending on the type of loan.

Rents cannot rise beyond incomes either. Rents may increase as the bubble deflates and could potentially lessen price declines, but both are ruled by income.

If incomes (stagnate at best, not to mention rising unemployment i.e. fewer people with those incomes) don’t keep up with the cost of either then both are overinflated. I can see how rents and prices could stay high for a while in a transitional period, and diminish in appearance the size of the bubble, but I don’t see how both can stay unaffordably high long enough for incomes to catch up. The same reason people are losing their homes will mean they eventaully can’t afford higher rents. Going into a housing-induced recession will eventually lead to a deeper drop in rents and prices, until incomes catch up. And if the past 2 bubbles are any indication, there will be an over-correction.

I think we will start to see people move away in droves from these high cost markets.

[cr]

Good points GD, and agreed Bugs. BobS, your point is good too, but payments can be mis-leading depending on the type of loan.

Rents cannot rise beyond incomes either. Rents may increase as the bubble deflates and could potentially lessen price declines, but both are ruled by income.

If incomes (stagnate at best, not to mention rising unemployment i.e. fewer people with those incomes) don’t keep up with the cost of either then both are overinflated. I can see how rents and prices could stay high for a while in a transitional period, and diminish in appearance the size of the bubble, but I don’t see how both can stay unaffordably high long enough for incomes to catch up. The same reason people are losing their homes will mean they eventaully can’t afford higher rents. Going into a housing-induced recession will eventually lead to a deeper drop in rents and prices, until incomes catch up. And if the past 2 bubbles are any indication, there will be an over-correction.

I think we will start to see people move away in droves from these high cost markets.

[EconProf]

BobS
gdcox makes a valid point by challenging the income/house price ratio. Since the earlier period had artificially high interest rates, house PAYMENTS were unnaturally high. We all remember that Volcker had to use 15%+ interest rates as a battering ram to wipe out inflation and inflationary psychology. Housing was the collateral damage.
In contrast, the bubble was stimulated by unduly low interest rates for several years under Greenspan.
A better ratio might be income/house payments.

[EconProf]

BobS
gdcox makes a valid point by challenging the income/house price ratio. Since the earlier period had artificially high interest rates, house PAYMENTS were unnaturally high. We all remember that Volcker had to use 15%+ interest rates as a battering ram to wipe out inflation and inflationary psychology. Housing was the collateral damage.
In contrast, the bubble was stimulated by unduly low interest rates for several years under Greenspan.
A better ratio might be income/house payments.

[EconProf]

BobS
gdcox makes a valid point by challenging the income/house price ratio. Since the earlier period had artificially high interest rates, house PAYMENTS were unnaturally high. We all remember that Volcker had to use 15%+ interest rates as a battering ram to wipe out inflation and inflationary psychology. Housing was the collateral damage.
In contrast, the bubble was stimulated by unduly low interest rates for several years under Greenspan.
A better ratio might be income/house payments.

[EconProf]

BobS
gdcox makes a valid point by challenging the income/house price ratio. Since the earlier period had artificially high interest rates, house PAYMENTS were unnaturally high. We all remember that Volcker had to use 15%+ interest rates as a battering ram to wipe out inflation and inflationary psychology. Housing was the collateral damage.
In contrast, the bubble was stimulated by unduly low interest rates for several years under Greenspan.
A better ratio might be income/house payments.

[patientlywaiting]

I monitor the rental market and I concur with Bugs. There is a lot of resistance to lowering rents, but I see cracks out there. It won’t be long before we see rent reductions (on residential and commmercial).

[patientlywaiting]

I monitor the rental market and I concur with Bugs. There is a lot of resistance to lowering rents, but I see cracks out there. It won’t be long before we see rent reductions (on residential and commmercial).

[patientlywaiting]

I monitor the rental market and I concur with Bugs. There is a lot of resistance to lowering rents, but I see cracks out there. It won’t be long before we see rent reductions (on residential and commmercial).

[patientlywaiting]

I monitor the rental market and I concur with Bugs. There is a lot of resistance to lowering rents, but I see cracks out there. It won’t be long before we see rent reductions (on residential and commmercial).

[patientlywaiting]

I monitor the rental market and I concur with Bugs. There is a lot of resistance to lowering rents, but I see cracks out there. It won’t be long before we see rent reductions (on residential and commmercial).

[Ex-SD]

There are two, little obstacles that buyers and sellers will have to overcome to buy and sell their properties in the bubble markets:
1. Get an appraisal that matches the selling price
2. Get a loan
Without either, you don’t have a sale (unless you have a cash buyer).

As prices continue to drop (and drop and drop), rents will also eventually drop. Bugs has it right in his post above.

[Ex-SD]

There are two, little obstacles that buyers and sellers will have to overcome to buy and sell their properties in the bubble markets:
1. Get an appraisal that matches the selling price
2. Get a loan
Without either, you don’t have a sale (unless you have a cash buyer).

As prices continue to drop (and drop and drop), rents will also eventually drop. Bugs has it right in his post above.

[Ex-SD]

There are two, little obstacles that buyers and sellers will have to overcome to buy and sell their properties in the bubble markets:
1. Get an appraisal that matches the selling price
2. Get a loan
Without either, you don’t have a sale (unless you have a cash buyer).

As prices continue to drop (and drop and drop), rents will also eventually drop. Bugs has it right in his post above.

[Ex-SD]

There are two, little obstacles that buyers and sellers will have to overcome to buy and sell their properties in the bubble markets:
1. Get an appraisal that matches the selling price
2. Get a loan
Without either, you don’t have a sale (unless you have a cash buyer).

As prices continue to drop (and drop and drop), rents will also eventually drop. Bugs has it right in his post above.

[Alex_angel]

Houses are only worth what people will pay for them bubble or no bubble. Simple economics.

If people didn’t want a $800k home then they wouldn’t buy it.

[Alex_angel]

Houses are only worth what people will pay for them bubble or no bubble. Simple economics.

If people didn’t want a $800k home then they wouldn’t buy it.

[Alex_angel]

Houses are only worth what people will pay for them bubble or no bubble. Simple economics.

If people didn’t want a $800k home then they wouldn’t buy it.

[Alex_angel]

Houses are only worth what people will pay for them bubble or no bubble. Simple economics.

If people didn’t want a $800k home then they wouldn’t buy it.

[Alex_angel]

Houses are only worth what people will pay for them bubble or no bubble. Simple economics.

If people didn’t want a $800k home then they wouldn’t buy it.

[kev374]

gdcox, I disagree with you. The multiplier was the average and interest rates have not been high throughout the period. Furhter income growth in the last 7 years has lagged inflation and the long term trend is that there will be further depression on income on white collar jobs because of global wage arbitrage.

[kev374]

gdcox, I disagree with you. The multiplier was the average and interest rates have not been high throughout the period. Furhter income growth in the last 7 years has lagged inflation and the long term trend is that there will be further depression on income on white collar jobs because of global wage arbitrage.

[kev374]

gdcox, I disagree with you. The multiplier was the average and interest rates have not been high throughout the period. Furhter income growth in the last 7 years has lagged inflation and the long term trend is that there will be further depression on income on white collar jobs because of global wage arbitrage.

[kev374]

gdcox, I disagree with you. The multiplier was the average and interest rates have not been high throughout the period. Furhter income growth in the last 7 years has lagged inflation and the long term trend is that there will be further depression on income on white collar jobs because of global wage arbitrage.

[kev374]

gdcox, I disagree with you. The multiplier was the average and interest rates have not been high throughout the period. Furhter income growth in the last 7 years has lagged inflation and the long term trend is that there will be further depression on income on white collar jobs because of global wage arbitrage.

[raptorduck]

Ex-SD. You beat me to the punch. I was just about to post that article.

[raptorduck]

Ex-SD. You beat me to the punch. I was just about to post that article.

[raptorduck]

Ex-SD. You beat me to the punch. I was just about to post that article.

[raptorduck]

Ex-SD. You beat me to the punch. I was just about to post that article.

[Bugs]

One thing I’m starting to see at ground level is that the softening of the rental structure seems to be spreading.

In the past there have been periods were rents retracted a bit, although never anywhere near the extent that pricing has ebbed off of a peak. However, we’ve never had a period where rents have increased as quickly and as much as they did over the last 7 years. The ‘wealth effect’ became so pervasive in our economy that it even got into the rental market this time, whereas past increases were much more limited.

Depending on what happens in the general economy in this region over the next years I think there’s some possibility of the some significant rental declines. The mighty RE economic engine has derailed and the wages that are being lost there – directly and indirectly – aren’t coming back any time soon.

The bottom line is that regardless of how nice San Diego weather is, most people have no incentive to spend half of their gross income on their housing unless there’s a profit margin in the near term. Renters will always be acting in their own best interests and rental pricing is a huge consideration, so it will always be competitive.

So while I do expect pricing to level off when it nears parity with rental incomes, I also expect rents to retract some too. Just as with pricing, the desirable areas will be among the last where this happens, but if the general trend continues long enough it’ll eventually reach into those neighborhoods too.

[Bugs]

One thing I’m starting to see at ground level is that the softening of the rental structure seems to be spreading.

In the past there have been periods were rents retracted a bit, although never anywhere near the extent that pricing has ebbed off of a peak. However, we’ve never had a period where rents have increased as quickly and as much as they did over the last 7 years. The ‘wealth effect’ became so pervasive in our economy that it even got into the rental market this time, whereas past increases were much more limited.

Depending on what happens in the general economy in this region over the next years I think there’s some possibility of the some significant rental declines. The mighty RE economic engine has derailed and the wages that are being lost there – directly and indirectly – aren’t coming back any time soon.

The bottom line is that regardless of how nice San Diego weather is, most people have no incentive to spend half of their gross income on their housing unless there’s a profit margin in the near term. Renters will always be acting in their own best interests and rental pricing is a huge consideration, so it will always be competitive.

So while I do expect pricing to level off when it nears parity with rental incomes, I also expect rents to retract some too. Just as with pricing, the desirable areas will be among the last where this happens, but if the general trend continues long enough it’ll eventually reach into those neighborhoods too.

[Bugs]

One thing I’m starting to see at ground level is that the softening of the rental structure seems to be spreading.

In the past there have been periods were rents retracted a bit, although never anywhere near the extent that pricing has ebbed off of a peak. However, we’ve never had a period where rents have increased as quickly and as much as they did over the last 7 years. The ‘wealth effect’ became so pervasive in our economy that it even got into the rental market this time, whereas past increases were much more limited.

Depending on what happens in the general economy in this region over the next years I think there’s some possibility of the some significant rental declines. The mighty RE economic engine has derailed and the wages that are being lost there – directly and indirectly – aren’t coming back any time soon.

The bottom line is that regardless of how nice San Diego weather is, most people have no incentive to spend half of their gross income on their housing unless there’s a profit margin in the near term. Renters will always be acting in their own best interests and rental pricing is a huge consideration, so it will always be competitive.

So while I do expect pricing to level off when it nears parity with rental incomes, I also expect rents to retract some too. Just as with pricing, the desirable areas will be among the last where this happens, but if the general trend continues long enough it’ll eventually reach into those neighborhoods too.

[Bugs]

One thing I’m starting to see at ground level is that the softening of the rental structure seems to be spreading.

In the past there have been periods were rents retracted a bit, although never anywhere near the extent that pricing has ebbed off of a peak. However, we’ve never had a period where rents have increased as quickly and as much as they did over the last 7 years. The ‘wealth effect’ became so pervasive in our economy that it even got into the rental market this time, whereas past increases were much more limited.

Depending on what happens in the general economy in this region over the next years I think there’s some possibility of the some significant rental declines. The mighty RE economic engine has derailed and the wages that are being lost there – directly and indirectly – aren’t coming back any time soon.

The bottom line is that regardless of how nice San Diego weather is, most people have no incentive to spend half of their gross income on their housing unless there’s a profit margin in the near term. Renters will always be acting in their own best interests and rental pricing is a huge consideration, so it will always be competitive.

So while I do expect pricing to level off when it nears parity with rental incomes, I also expect rents to retract some too. Just as with pricing, the desirable areas will be among the last where this happens, but if the general trend continues long enough it’ll eventually reach into those neighborhoods too.

[gdcox]

The analysis uses the average ratio of median income to median prices between the mid-70s and 2001 (2.8 ‘income multiplier’) to calculate the size of the current bubble.

Whilst I am no apologist for or denigrator of the theory of the bubble (it exists, is big and ugly and I would hang all brokers who sold 100% plus sub-prime loan to value mortgages in recent years!), there are in my view two notes of caution that needs to be applied regarding this bubble size work.

1) The period chosen (mid 70s to 2001) includes a first half when mortgage interest rates were abnormally high (for a variety of reasons). The abnormally high mortgage rates then (in nominal and real terms) had the effect of constraining the income multiplier because mortgage demand was unnaturally limited and hence prices were at a lower level . So I think the ‘normal’ multiplier is larger than 2.8 and hence the scale of the bubble today is smaller than the authors say.
2) As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse. I suspect that point is well above the level suggested in the article because rents have probably risen a more than have median incomes: eg I don’t think California will go down 60% (recent level to bottom as the article suggests) even if as seems likely foreclosure sales keep on rising.

I sadly do not have time to do the analysis suggested above, but I suspect that the factors above mean that the bottom is above the non-bubble average national, state or city price level stated in the article; though I am conscious that in some micro areas there will be a huge undershoot of prices simply because of the shear scale of new subdivisions put into the market by new build well away from centres of employment (eg DR Horton’s 50% fire sale) .

Have I missed anything?

Graham Cox

[gdcox]

The analysis uses the average ratio of median income to median prices between the mid-70s and 2001 (2.8 ‘income multiplier’) to calculate the size of the current bubble.

Whilst I am no apologist for or denigrator of the theory of the bubble (it exists, is big and ugly and I would hang all brokers who sold 100% plus sub-prime loan to value mortgages in recent years!), there are in my view two notes of caution that needs to be applied regarding this bubble size work.

1) The period chosen (mid 70s to 2001) includes a first half when mortgage interest rates were abnormally high (for a variety of reasons). The abnormally high mortgage rates then (in nominal and real terms) had the effect of constraining the income multiplier because mortgage demand was unnaturally limited and hence prices were at a lower level . So I think the ‘normal’ multiplier is larger than 2.8 and hence the scale of the bubble today is smaller than the authors say.
2) As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse. I suspect that point is well above the level suggested in the article because rents have probably risen a more than have median incomes: eg I don’t think California will go down 60% (recent level to bottom as the article suggests) even if as seems likely foreclosure sales keep on rising.

I sadly do not have time to do the analysis suggested above, but I suspect that the factors above mean that the bottom is above the non-bubble average national, state or city price level stated in the article; though I am conscious that in some micro areas there will be a huge undershoot of prices simply because of the shear scale of new subdivisions put into the market by new build well away from centres of employment (eg DR Horton’s 50% fire sale) .

Have I missed anything?

Graham Cox

[gdcox]

The analysis uses the average ratio of median income to median prices between the mid-70s and 2001 (2.8 ‘income multiplier’) to calculate the size of the current bubble.

Whilst I am no apologist for or denigrator of the theory of the bubble (it exists, is big and ugly and I would hang all brokers who sold 100% plus sub-prime loan to value mortgages in recent years!), there are in my view two notes of caution that needs to be applied regarding this bubble size work.

1) The period chosen (mid 70s to 2001) includes a first half when mortgage interest rates were abnormally high (for a variety of reasons). The abnormally high mortgage rates then (in nominal and real terms) had the effect of constraining the income multiplier because mortgage demand was unnaturally limited and hence prices were at a lower level . So I think the ‘normal’ multiplier is larger than 2.8 and hence the scale of the bubble today is smaller than the authors say.
2) As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse. I suspect that point is well above the level suggested in the article because rents have probably risen a more than have median incomes: eg I don’t think California will go down 60% (recent level to bottom as the article suggests) even if as seems likely foreclosure sales keep on rising.

I sadly do not have time to do the analysis suggested above, but I suspect that the factors above mean that the bottom is above the non-bubble average national, state or city price level stated in the article; though I am conscious that in some micro areas there will be a huge undershoot of prices simply because of the shear scale of new subdivisions put into the market by new build well away from centres of employment (eg DR Horton’s 50% fire sale) .

Have I missed anything?

Graham Cox

[gdcox]

The analysis uses the average ratio of median income to median prices between the mid-70s and 2001 (2.8 ‘income multiplier’) to calculate the size of the current bubble.

Whilst I am no apologist for or denigrator of the theory of the bubble (it exists, is big and ugly and I would hang all brokers who sold 100% plus sub-prime loan to value mortgages in recent years!), there are in my view two notes of caution that needs to be applied regarding this bubble size work.

1) The period chosen (mid 70s to 2001) includes a first half when mortgage interest rates were abnormally high (for a variety of reasons). The abnormally high mortgage rates then (in nominal and real terms) had the effect of constraining the income multiplier because mortgage demand was unnaturally limited and hence prices were at a lower level . So I think the ‘normal’ multiplier is larger than 2.8 and hence the scale of the bubble today is smaller than the authors say.
2) As a financial economist by background, I think the methodology of using static data from the past is suspect; especially in isolation. Much better to make a current dynamic comparison with the rental markets. As house prices fall this and possibly next year, there will come a point at which it is cheaper for people to buy on a mortgage than to rent and another point at which the rental yield on repossessed properties becomes irresistibly attractive for landlords. These two points may coincide in time of not. But either way, the bubble will have been eliminated by definition when landlord and renters are incentivized and act to buy en masse. I suspect that point is well above the level suggested in the article because rents have probably risen a more than have median incomes: eg I don’t think California will go down 60% (recent level to bottom as the article suggests) even if as seems likely foreclosure sales keep on rising.

I sadly do not have time to do the analysis suggested above, but I suspect that the factors above mean that the bottom is above the non-bubble average national, state or city price level stated in the article; though I am conscious that in some micro areas there will be a huge undershoot of prices simply because of the shear scale of new subdivisions put into the market by new build well away from centres of employment (eg DR Horton’s 50% fire sale) .

Have I missed anything?

Graham Cox

[SHILOH]

Is the median home price to median income correlation reliable to predict income to house market trends, if there is no data to show percentages of households who earn “the median ie $55K, v. the number of homes priced at the median?

I would think the only way to figure how long an inventory of median priced homes would last…is to know how many households have a median income.

Since the median is not the same as the average. What if the median is $55K but the average is $80K?

[SHILOH]

Is the median home price to median income correlation reliable to predict income to house market trends, if there is no data to show percentages of households who earn “the median ie $55K, v. the number of homes priced at the median?

I would think the only way to figure how long an inventory of median priced homes would last…is to know how many households have a median income.

Since the median is not the same as the average. What if the median is $55K but the average is $80K?

[SHILOH]

Is the median home price to median income correlation reliable to predict income to house market trends, if there is no data to show percentages of households who earn “the median ie $55K, v. the number of homes priced at the median?

I would think the only way to figure how long an inventory of median priced homes would last…is to know how many households have a median income.

Since the median is not the same as the average. What if the median is $55K but the average is $80K?

[SHILOH]

Is the median home price to median income correlation reliable to predict income to house market trends, if there is no data to show percentages of households who earn “the median ie $55K, v. the number of homes priced at the median?

I would think the only way to figure how long an inventory of median priced homes would last…is to know how many households have a median income.

Since the median is not the same as the average. What if the median is $55K but the average is $80K?

[SHILOH]

Is the median home price to median income correlation reliable to predict income to house market trends, if there is no data to show percentages of households who earn “the median ie $55K, v. the number of homes priced at the median?

I would think the only way to figure how long an inventory of median priced homes would last…is to know how many households have a median income.

Since the median is not the same as the average. What if the median is $55K but the average is $80K?

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