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Ritholtz: The worst is behind us on housing

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Barry Ritholtz, who some would say has been "bearish" on housing but who's also been right about it, thinks the worst is behind us:

My basis for saying the worst is likely over are prices: We are off 33% from the peak, and as of the end of Q1, were ~5-15% over fair value by traditional metrics. So a return to fair value — even a 15% drop in 2011 — still means the worst is (was) behind us.

If houses were to careen far below fair value — they were about 40% overvalued, so in theory, they could overshoot 40% to the downside — then my valuation thesis would be wrong. There are lots of ways house prices could drop much further: If jobs and income plummet from here, home prices will be too high. If interest rates spike, prices will adjust downward. If the mortgage deduction were to be eliminated, prices fall also. IMO, these are smaller possibilities — say 20-25% chance — then merely mean reverting towards historic relationships with median income, cost of renting, and home equity as a percentage of GDP.

Out of curiosity: Do we have historical examples of housing becoming extremely undervalued?

By Ezra Klein  |  September 13, 2010; 9:30 AM ET
Categories:  Housing Crisis  
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Comments

Ezra,

Robert Shiller has some data on real house prices going back to 1890.

The 1890-2010 average was 107.53 (100 = 1890), and the average for the 1990s
was 114.27. Today the index is at 129.69.

Real house prices sank from 96.98 in 1914 to 66.07 in 1920 as prices failed to keep up with the Great War inflation, and stayed below 80 until the 1940s.

http://www.econ.yale.edu/~shiller/data.htm

Now this is a different calculation than fundamental value, but at the same time the long term trend for real house price appreciation is about zero (+0.2%/yr 1890-2010), and so the long run average is probably more or less fair value.

I'm not sure this proves housing was significantly undervalued from 1918-1945, but it seems possible given the trend over the last 120 years.

Posted by: justin84 | September 13, 2010 9:46 AM | Report abuse

Here's another factoid to ponder: US house prices peaked (IIRC) in late 2006. Since then the US population -- even though it's been growing more slowly than at any time in decades -- has expended by at least 10 million or so, even as house construction has plummeted. At some point, that translates into more crowded living conditions, and that, in turn, stokes demand and helps put a floor under prices.

I know from spending lots of time on the internets that many people from all over the political spectrum lose sleep at night worrying about immigration-induced population growth (and population growth in general), but for my money, probably the single strongest counter-factor shielding the US from a Japanese-style deflation/lost decade is the fact that, unlike Japan, the US continues to experience population growth that is robust by rich world standards.

Posted by: Jasper999 | September 13, 2010 11:06 AM | Report abuse

Jasper999,

The crowded living conditions are a long way off - vacancy rates are just off record highs going back over 40 years.

Assuming populaton growth of 2.5 million/yr and 2.5 people per household, that implies we could run with ~19 months of no construction before vacancy rates returned to normal, let alone risk crowded conditions. With housing starts running ~0.5 million annually, it will take close to 3 years to return to normal vacancy levels (1.6 million excess housing units + 1.5 million units constructed less 3.0 million new units required and less some number of units lost over that time).

http://www.calculatedriskblog.com/2010/09/housing-starts-and-vacant-units.html

http://www.calculatedriskblog.com/2010/07/q2-2010-homeownership-rate-lowest-since.html

Posted by: justin84 | September 13, 2010 11:39 AM | Report abuse

If after tax wages don't rise, fair value, upon which Ritzholt bases his ratios, may drop. On the other hand, we may actually succeed in inducing inflation.

Posted by: staticvars | September 13, 2010 12:12 PM | Report abuse

*****The crowded living conditions are a long way off - vacancy rates are just off record highs going back over 40 years*****

No argument from mere here. But the point is, they're OFF record highs -- and headed in the right direction.

Every little bit helps...

Posted by: Jasper999 | September 13, 2010 2:58 PM | Report abuse

Ezra,
I suggest that this (Shiller's data) is surely the first-choice national price metric:
http://www.nytimes.com/imagepages/2006/08/26/weekinreview/27leon_graph2.html
This noted behavior:
"Two gains in recent decades were followed by returns to levels consistent since the late 1950's."
together with Shiller’s reckoning that nationally we are not running out of land -- really is coherent!

Up to date is first chart, in green, here:
http://homepage.mac.com/ttsmyf/RD_RJShomes_PSav.html
In last chart, trace is 66.5 in 2010 Q2, inferred will return to about 54., that’s a drop of 19% in real price -- would be the same for nominal price if constant CPI-U.

Posted by: ttsmyf | September 13, 2010 4:04 PM | Report abuse

Undervalued based on what set of criteria?

(e.g. due to an over-correction on the downside of a housing bubble?)

e.g. Changes in lending criteria can have a profound impact on the value of real estate prices. Interest rates can have a profound impact on real estate prices. Real wages can have an impact on real estate prices (although apparently not so much in recent years). Inventories have an impact on prices.

Based on the lending criteria and interest rates of the mid 1980s real estate was apparently substantially undervalued (although that would have been a hard argument to make to someone during the 1991 recession).

All other factors being equal: If the expectation is that in the next 20 years lending criteria will return to the standards of the early and mid 2000s and rates will remain at the current levels for years to come, it's conceivable that current purchasers today will realize some upside benefit in price appreciation over the next 5 to 10 years.

On the other hand, if lending standards tighten to something more in line with historical norms and/or if you have an environment where we eliminate GSEs without any viable private sector alternative, it's entirely conceivable that present values in real estate will look inflated. Also, it's hard to see interest rates remaining at current levels for a sustained period. They will rise eventually and when they do the impact of rising interest rates is likely to put a limit on price growth -- even in an environment where wages-income increase. There are obviously a number of factors at work, which can impact price movements in either direction.

Ritholtz's qualifications seem to be pretty conservative. (e.g. he is not saying that there will be no further depreciation, in fact he thinks another 10-15 percent drop is possible in the near term -- he just seems to believe that another period of 40 percent drops is unlikely).

Posted by: JPRS | September 14, 2010 2:57 AM | Report abuse

Ezra,

I'm pretty sure there was a housing under-valued period around depression and WWII.

See Case-Shiller curve. Other periods had buying cheaper than renting, too. 100=same cost.

Posted by: rat-raceparent | September 14, 2010 2:04 PM | Report abuse

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