According to Don’t Buy the Bubble Talk [SmartMoney.com] “housing costs are now only a bit above historic norms, and are not extreme even in boomtowns like Miami and San Diego.”
According to a study completed this fall by Todd Sinai of Wharton School, University of Pennsylvania, Chris Mayer of Columbia Business School and Charles Himmelberg of the Federal Reserve Bank of New York, homeownership costs are near the long-term average, relative to rents and incomes.
Traditional measures of housing values, such as the rate of appreciation, or the house-price-to-rent ratio, are misleading.
“The study by Sinai and his colleagues examined 46 housing markets from 1980 to 2004, estimating the true one-year cost of owning a house and comparing it to rental costs and income levels. Naturally, the low interest rates of recent years have offset high prices by keeping mortgage payments down. Variable and interest-rate-only mortgages have also lowered the annual dues of homeownership.”
“It’s tricky; economists think about bubbles differently from how lay people think about bubbles. [Rapidly increasing prices] is not the definition of a bubble… You could have a big price change without it having been a bubble. “
This study reflects the way people have been viewing housing as an asset class. People have been purchasing based on payment, not price in this latest boom.
What has bothered me about the real estate market and whether or not there is a bubble seems to have two camps:
From one extreme: there is a bubble:
Prices are rising so fast that housing is going to crash. This is what I was referring to last week with my post on bubble blogs [Matrix]. These are well written blogs and are based on the basic principal that prices are going to high too quickly.
To another extreme: there is no bubble:
Prices have been showing such strength over the past few years and demand so high that there is no bubble. This is a classic case of using historical to prove current conditions when the past does not take into consideration what is happening right now.
Extreme conclusion: there are many that are passionate about both arguments.
Are we sure that there has to be an extreme conclusion to all of this, or does it simply make for better reading?
To me it doesn’t matter what terminology you use to describe market trends, but rather how you view them. If a market indicator historically increases 4-5% per year on average, then it is under-performing when the rate drops below this point and is over-performing when it rises above it. So either the “rules” change (i.e. tax laws, lending requirements, economic forces, etc.), or the market is “historically” out of balance.
As for real estate, the most significant tax law changes took place in 1997 when homeowners could pocket up to $500,000 of capital gains on a sale on a primary residence and in 2003 with the reduction of capital gains tax rates. During the past few years lending requirements have been reduced to the point where buyers with less than perfect credit can finance deals with no money down and sellers pay the closing costs. As for economic forces, the mighty Federal Reserve, in all its recent rate increases, was confounded when foreign investors snapped up mortgage securities, which inverted the rates on 30 year mortgages and home equity loans.
I think it’s safe to assume the “rules” are about as pro-real estate as they have ever been. In fact, there is talk of capping mortgage interest deductions, which is politically do-able considering it will only impact 5-10% of the homeowner population (mostly in places like New York and California). The lending community, driven by the investment environment, has always been fickle and requirements would quickly be modified should home price drop a mere 10%. Lastly, the foreign investors have a whole world of investments to choose from. So what’s a good word for mucho fickle?
I think it is widely accepted that markets correct themselves and maintain a “historical” balance. If this is true, then the housing market is probably due to correct itself, as it has clearly over-performed during the past few years, and there appears to be no further stimulus on the horizon.
Isn’t it “Murphy’s Law” that if something “can happen”, it eventually “will happen”. We’ve had real estate crashes in the past, so isn’t it logical to assume we will have more in the future?? The main question is when? I’d guess July 2006.
The change in the tax law allowing people to pocket $500k of profit tax free was a replacement for the rollover rule. If you rolled over your sale into a new purchase, you deferred taxes on the gain. I know the new rule is more favorable for real estate, but since you gotta’ live someplace and most owners stay owners, I don’t see how the $500k rule really could be held responsible for the performance of real estate. It seems to me that it really only helps those few people who are downsizing or selling in expensive areas and buying in cheaper areas (people retiring, for example). The big driver has been interest rates. A renter looking to become an owner compares the cash necessary to rent vs. the cash necessary to own. The other two factors — the impact of mortgage tax deductibility and the impact on total ownership costs of appreciation (or depreciation) — are also important. The tax impact can easily be converted to a cash basis, but appreciation expectations are very fickle and probably much more important than given credit for. Nonetheless, mortgage rates are still near historical lows and provide a positive driver to real estate.
Looking at long term historical rates of housing appreciation and saying if it is below the trend the market is due for a bump up and if above the trend the market is overpriced is like saying “on average, the weather will be average”. No one ever believes that since the last two winters were really cold that this winter will be warm to average things out. Rather, they say last winter was cold, this will be cold, too. It isn’t accurate, but it is how we behave.
The people who are intent on believing in a housing “bubble” are largely the same people who lost big on the downfall of tech stocks in the late 90s. Their investing ideas are shaped by that transformative experience. Ironically, those people are bedeviled by the same problem now: they are ignoring fundamentals, which show that while growth may slow, no crash is in sight.
There was a crash around 1990 as well. I remember looking at a studio in Tudor City to rent in 1992. The agent mentioned it was a co-op being rented by the owner. Oh, I said, are there many for sale here? Oh, said the agent, how many do you want?