Adjusted Case Schiller Housing Data

After reading an article from a fellow Seeking Alpha contributor with Case-Schiller housing appreciation data for the 1990s and for the ‘00s thru May of this year, I began to wonder how the data would look if:

It was expressed on an annualized return basis

It was adjusted for the “housing expense ratio” AKA Taxes & Mortgage Interest

I crunched some numbers and came up with the tables below, which depict the gross and real (after the expense ratio) return from housing within 17 major markets/metro areas, on a total and annualized basis for the 1990s and the for the period of January 2000 thru March 2007. The tables were created based on the following assumptions:

A $300,000.00 home was purchased at the beginning of the period.

The home was financed with a 6.5% APR fixed rate mortgage, and an 80% LTV/$60k down payment.

The home owner has a top marginal rate of 28% (Obviously, tax rates fluctuated over this time period, but this keeps things simple).

Property taxes were levied at 2% of purchased over the duration of the entire time period (not likely, but I did it this way for simplicity’s sake).

I didn’t factor in maintenance due to the many factors that impact those costs: condo vs. townhouse vs. stand alone dwelling, age of the home, etc.

It’s worth noting, that in order to be truly accurate, some sort of “baseline housing cost” would need to be factored into the calculations, since you have to pay for housing whether you rent or buy. In order to determine one’s true return from housing the “baseline housing cost” would need to be subtracted from the housing expense ratio, in order to determine the real net return. However, this is hard to do on an aggregate basis (OER is highly flawed) as rental costs are really determined by an individual’s taste and living situation more than anything else.

First, let’s look at the table for the 1990s:

Now, you can’t discuss 1990s housing prices without first acknowledging that during the early 90s, we were dealing with the tail end of the S & L crisis, there was a recession and declines in residential real estate values in many cities. At the same time, the later part of the ‘90s was a time period of tremendous economic growth, low unemployment, low inflation, etc, and for many individuals the 90s economy was superior to the recent real estate boom years.

Looking at the data itself, the first thing that jumps out is that despite the fact that homes in nearly all markets showed “some” level of gross appreciation, they were all negative for the 1990s when you factor in taxes and interest expense. You would almost think that even with the economic difficulties of the early 90s factored in, that you’d see very strong appreciation overall as the markets recovered and people had more disposable income during the boom years of the mid to late 90s.

Now, let’s look at the housing data for the ‘00s

Of course, we all know the story here, housing boom, rapid appreciation, cheap money, foreclosures and the subsequent mortgage crisis. What was immediately interesting to me is how much some high flying markets came down to the earth once the expense ratio was factored in and how the boom was really concentrated in a small number of markets with other markets merely being along for the ride. Some key things to take away from the two charts:

Cheap money, speculation and relaxed lending standards can potentially drive housing appreciation more than rising incomes and a strong economy.

Home owners are due for a major expectation reset over the coming years; I wonder if a major reset in expectations might serve to depress prices even further.

Many home owners who bought at the beginning of the 90s and sold at the end, may have felt they turned a profit (typical anecdote I bought for $300k and sold for $450k), but home owners simply can’t ignore their interest and taxation costs when determining their returns.

Home Owners should probably think of their homes more as purchased assets with “potential” investment value, as opposed to investments in general; especially as the Real Estate market continues to correct and we return to a pre-housing boom environment, both in terms of prices and appreciation.

Financing costs can be the difference between your house “performing like an investment” or “performing like pure consumption”. Subprime borrowers probably didn’t do too well net return wise, even in markets like LA and Miami.

Home owners who used zero money down, negative amortization and interest only mortgages, particularly those who purchased in the last 2-3 years, may go for well over a decade before seeing any return at all.

Your local housing market can go through a boom period and still lag the equities market, only four of the 17 markets beat the S & P 500’s 8.5% return over the time period.

Home owners often purchase homes based on expected returns which are based on price appreciation, when they should really be considering their return after taxes and interest. Price appreciation measures the cost of waiting to buy a home, not your actual return.

As we move beyond the mortgage/real estate crisis, one of the more interesting potential changes could be to homeowner psychology, as the mood shifts from “real estate as a must have, can’t lose” to one where home buying is properly viewed as (at best) a “consumption-investment hybrid”. Furthermore, due to the various factors inflating housing prices, it’s quite likely that many home owners won’t see returns on a real basis for an extended period of time. Housing may become reminiscent of tech stocks where few of tech’s former high-fliers (even if they’re quite profitable today) have seen their stock prices return to tech boom levels.

Comments

[aibyouka:]

to make analysis more realistic potential rent income / or avoided rent expense if the house used for living should be taken into account.
$300k home renting for 2,500k/month (conservative estimate based on current Houston market) would make quite a difference to net return

2007 Sep 07 10:29 AM

[Markham Lee:]

The problem is this: would a person who can afford to buy a $300k home, pay a higher cost to rent one instead? It's not a realistic scenario, more realistic is that they traded up from a cheaper home or a rental property with a lower rent.

I think the best way to consider potential returns is to look at the likely, real life scenario.


-M

2007 Sep 07 12:52 PM

[LLOYD2K:]

....when they should really be considering their return after taxes ....... Did you include in the annul profit the realization of an increase in income tax refunds of $5880? this figure alone makes home ownership viable if the monthly payment including taxes and insurance is less than $400/month than the going rate for rent on a comparable dwelling.

2007 Sep 08 11:36 AM

[Markham Lee:]

I'm not sure where you're getting the number of $5,880.00 - but the data does have the tax benefit factored in. I assume the person is in the 28% tax bracket and adjust their interest expenses accordingly.

It's also worth noting that the tax benefit is a bit of a misnomer:

1) It's only a "discount on your interest" so buying a home for the tax benefit, is akin to buying a TV to make money via the $50 rebate.

2) When you use the mortgage tax deduction, you have to itemize your deductions therefore giving up the standard deduction, which makes your effective tax savings less than many think.

For a single person the standard deduction is $5,350 and for a married person the standard deduction is $10,700.00. So, in terms of the tax benefit over a married person, you're really only benefiting by the amount OVER the standard deduction - even though it's standard practice to depreciate the entire interest expense and not just the amount over one's standard deduction.

For the this example, first year interest is $15,521.02.

A married person really only saves on the interest over the standard deduction or on $4,821.02 of their interest, whilst for a single person it would be $10,171.02. Net impact? The tax benefit amounts to $1,349.89 for a married person and $2,847.89 for a single person.

However, standard deduction amounts change annually and factoring it in properly would've made things quite complicated.

Still, it does wipe out a lot of the benefit from rent avoidance.

It's also worth noting, that married couples who purchase homes for less than $225,000.00 will see zero benefit from the tax aspect, as the first year interest (the most they'll ever pay) is less than the standard deduction.

-M

2007 Sep 10 08:16 PM

[WAdem:]

Yes, you probably could have made it more realistic with an adjustment for rents, although Houston is hardly the typical market. In California and Florida, million-dollar homes rent for $3500 per month!

Another oversight like the one mentioned, income tax benefit, is the less obvious lost opportunity of investing in equities. Dr. Shiller mentions that over the 1890 to 2006 period, I think, residential real estate has returned just slightly more than treasury bonds! Not a very appealing investment.

By the way, most of us are actually renters. We rent money from mortgage lenders to occupy their house (until we pay it off). It is little different from renting the same house from a landlord, in fact. And, as we are learning, with great financial risk. Think bankruptcy as the downside vs. "the American Dream".

2007 Sep 09 01:13 AM

[Mastery:]

Fascinating! I agree with much of what has been said. The OFHEO indexes say much the same thing. Average Year on Year appreciation is slightly under 6% a year averaged over a 20 year period. This is almost identical to per capita Federal spending appreciation year on year over the same period as well as with appreciation of per capita disposable income. This also matches the UK inflation rate almost identically as well as the appreciation of the price of gold. By contrast Stock market appreciation over the 20 years to August of this year was nearer to 10% average annual year on year appreciation. Thus substantial part of the stock market collapse seems related to overheating of equities rather than simply the credit crunch from the housing bubble which (on a long term basis anyway) is something of a myth EXCEPT in that it encouraged consumer borrowing through home equity loans, sub-prime, second mortgages or onerous consumer finance and largely based on an illusion of wealth creation from home equity that on a TRUE inflation adjusted basis simply did not exist. In turn this lenders were fuelled by easy capital from the banking system and from a Wall Street flush with cash direct from the Fed after the dot com bust and from absurdly overvalued equity markets creating compulsory purchase through indexation.

2008 Dec 02 03:31 AM