Missing From All the Credit Crisis Coverage: A Realistic Assessment of Where Home Prices Are Headed

One thing that's missing in all the coverage of the current credit crisis is a realistic assessment of where home prices are headed. There seems to be a consensus that we're past the worst, and that the real estate market will level off from here.

Am I missing something here?

I was just looking at the historical data on the Case-Shiller Real Estate Indexes, and decided to compare the performance of home prices during the 1990s and the 2000s (to date). The data is startling. The table below show cumulative performance through May 2007, sorted by performance this decade.

click to enlarge

Notice a difference between the two columns? Can you say, "reversion to the mean?"

People are panicking in these markets because prices have fallen 2-5% this year. What if we lop 30% off home prices? People dismiss that as ridiculous, but it would only take the market in Washington, DC, back to where it was in December 2003. How about 40%, which would take Los Angeles back to July 2003? Or 50%, which would take Miami back to August 2002.

Fifty percent may be a stretch, but 10%, 20% or even 30% strikes me as entirely probably. Doesn't anyone remember the Internet bubble around here?

Comments

[long timerealtor]

30 to 50% is not unrealistic in Palm Beach County Florida. That's what we are seeing right now!

[Malkiel]

An article elsewhere today pointed out the necessary relationship between median income and average housing prices. Unless income steadily increase in the next 3 years there will need to be a reversion of asking prices to the range of affordability. Only funny mortgage products were allowing people of ordinary means to control such expensive housing and those products have disappeared from the market...

[johnhhaskell]

especially when you consider that average wages have increased nowhere near 100% in the past decade. In fact Joe Public's paycheck is not even keeping up with inflation (see today's NYT for detail).

The only thing that has changed is the financing arrangements. Those are now going back to what we had before.

Then the only difference will be people's fond recollections of how they used to be "rich."

I believe that a 50% decrease in NV, FL and AZ is basically guaranteed.

[Efrain Rojas]

Even in a tight market like Los Angeles where rents have zoomed up in the last five years, rental income does not even come close to covering the cost of a mortgage. The so called experts in the media and business do such a deplorable job of anticipating obvious train wrecks coming down the tracks such as this credit crunch that it is ill advised for anyone to defer to their opinion. Anecdotal observation, based on the people I know and encounter everyday, suggests that the worst is still to come. When illegal immigrants without even a valid Social Security number can borrow $300,000 for a dumpy house in a bad neighborhood, common sense tells me that a crappy house is not worth $300,000.You would in fact have to pay me to live there.

Even if you could live rent free, most average income earners would find it impossible to amass $300,000 over ten years. Is it realistic to expect average earners to amortize such a large nut over 30 years? That is just not realistic.

[David Levin]

Why Florida house prices must continue to go lower

It is all about affordability

The housing market will force equilibrium to be achieved. House prices must come down to accomplish that if only for the fundamental reason of affordability.

The Florida market enjoyed a spectacular coming together of cheap, accessible, plentiful mortgage money, speculator’s irrational exuberance and under priced carrying costs. Prices soared and mortgage lending became increasingly exotic to accommodate the increases. The home purchaser focused on the monthly payment and mortgage loans were structured to maximize that. However, active hurricane seasons launched a series of exponential increases to insurance costs. Massive tax increases based on the market value of the house lagged by as much as a year, so many did not fully incorporate this added expense to the monthly carry. Often purchasers deluded themselves into believing a refinance into a cheaper new introductory rate would permit them to finance the added expense at little or no effect to the monthly payment.

Incomes did not keep pace with the inflation experienced in house prices. With the value of houses now deflating, refinancing is not a possibility. The higher levels of insurance and taxes have added significantly to the monthly carrying costs of a house and appear to be permanent. Mortgage loan interest rates do not appear to be substantially decreasing. The only remaining moving part in the equation is the price of the house.

It is all based on affordability. Affordability is based on the general wage levels of a market area. Substantial Tax and Insurance costs eat into the amount left to service the mortgage loan. The price of the house must come down sufficiently to bring the monthly carrying costs in line with the monthly take home pay. We still have a ways to go.
From Real Estate Analysis and Insight at
DavidLevin.org

[johnlewing]

as usual simple logic is the way to understand the situation:

1. asset value is based on cash flows (after-tax rental cash flows is a good starter) discounted at an appropriate rate to reflect the risk of the cash flows.

2. clearly houses in urban areas are overvalued on this basis, and probably substantially.

3. however, the comparison to prior periods is very tricky as general interest rates and interest rate expectations have come down over the past decade or two. in other words it's not an apples to apples comparison on the discount rate....whereas the cash flow estimates are probably reasonably comparable as long as inflation is considered.

bottom line is that they have to correct (and obviously have begun that process) but how fast and whether much of the loss will be "real" loss to inflation over time or a quicker nominal loss process.....nobody knows.

my guess is that prices will fall 10 % per year for a couple more years and in the end it will be nearly a 35% real loss and a 25% nominal loss on values.....

there will also be tax revolts throughout the land as the municipalities and townships hang on to their phony assessments and keep spending money foolishly and lavishly, especially on their own pensions.

johnny b. dog

[flyoverman]

Your sampling is limited. Emphasizing the high-appreciation urban real estate locations skews your presentation. There a lot of people that live in cities like Dallas, Houston, San Antonio, Detroit, Philadelphia, etc., etc. that aren't on the 10 city composite. That doesn't even include a lot of American who live outside of large urban "fly-over" country. Yes, real estate will "bust" in some place, but "boom" in others simultaneously. Please provide a more thorough analysis before making your conjecture.

[HalB]

I think your assessment is only partly correct, Michael. Those communities that enjoyed the largest increases will, no doubt, pay a greater price in the downturn. The "fly-over" country and other major metro areas you cite will probably continue to see small price appreciation as long as housing price increases have not outpaced wages and rents and taking into account the increase we will see in coming years as mortgage rates return to their historic levels in the upper-single-digits.

These controversial mortgage products that have been the catalyst for the credit crisis are unprecedented. I doubt we will see them revived any time soon. The real reason there is so much fear in the markets right now is that we have never been here before with so much debt and so many marginalized buyers.