The Housing Bubble Goes Pop

I believe the outlines of the bust are becoming as visible as the bubble itself was to any astute observer a few years ago. But, it has yet to hit bottom! If I had to guess, I'd say we are going to give back most of the integral over the curve from 1997 to 2007 or so, net of overall inflation during that period (say 20-30%). In other words, extend the blue trend line beyond the early nineties, and integrate your favorite curve minus this trend line from 1997-2007 to get the overvaluation. (Note the graph is of year over year price changes in nominal dollars, not absolute price.)

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Figure via Calculated Risk.

Or, just look at the figure below to see that prices might have to drop 30-40% to return to consistency with the long-term trend.

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As we've discussed before, house price increases tend to be quite modest if measured in real dollars. (Except, of course, for bubbles and special cases :-)

The Case-Shiller national index will probably be off close to 12% YoY (will be released in early to late May). Currently (as of Q4) the national index is off 10.1% from the peak.

The composite 10 index (10 large cities) is off 13.6% YoY. (15.8% from peak)

The composite 20 index is off 12.7% YoY. (14.8% from peak)

Comments

[john sabia:]

I think you may be on to something... I think end of 08 beginning of 09 we will start to see some stabilizing in my market.

2008 Apr 30 09:01 AM

[Tom B:]

Corrected for inflation, but not corrected for "inherent" value of the properties. Maybe people started buying much bigger houses in the "2000's"? Maybe demand is trending up because of increasing US population? Given me SOME reason to believe we aren't going to sink the that plateau level in 2nd graph.

2008 Apr 30 09:02 AM

[Pent up demand:]

Sorry Tom B. Last time I checked, we aren't close to running out of space to build new houses, so population growth won't have much affect. The effect of a preference for bigger houses will be shown as a premium relative to older/smaller homes, not as a permanent change in the overall price level.

At the end of the day, prudent people can only afford to spend a certain fraction of their income to buy housing. House prices must be tied to incomes. Repeat after me: my house is an expense, not an investment.

2008 Apr 30 10:14 AM

[Tom B:]

"House prices must be tied to incomes."

I have totally believed that for years. I don't have a good sense, as a small investor, though, where "THE" bottom will be. Nor do I know where "MY" bottom will be. I live in an area where housing prices have stayed fairly stable (as opposed to plummeting). I may need to sell within 12 months. I may need to move to an area that has lots of possibly STILL overvalued properties. So all these issues are of more than theoretical interest. I'd like to get through the next couple of years without realizing a real estate loss.

2008 Apr 30 10:33 AM

[BernieB:]

One more thing people seem to be missing is demographically the boomer's will want to migrate to smaller homes / retirement communities / long term care facilities. As part of this process more homes will go on the market to fund their expenses.

So John's comment about the market stabilizing in late 08-09 does not make sense to me. I see a longer period of negative growth perhaps lasting through 2012 - 2014 then the market will stabilize as the US opens immigration to help move the economy forward and help pay for US debt.

2008 Apr 30 10:33 AM

[ArnoldCountry:]

I too believe that "house prices must be tied to incomes". Another very important point. The recovery could be even more difficult down the road considering guidelines. Many of the persons who have been impacted and have had no choice but to walk away will be ineligible for borrowing from the current sources, the GSA's, for 3-5 years under their latest guidelines. That will limit your pool of buyers in the future who were traditionally in the pool before. On one hand the GSA's are punishing consumers who have sub-prime or Option ARM products that choked them to death by not lending to them in the future but expecting that someone will be there to buy to pull this housing slump out. Talk about shooting yourself in the foot! At this point, a prediction of a turn around in 08' is madness. Not even the serious litigation has started yet.

2008 Apr 30 11:25 AM

[Malkiel:]

That the price of homes is tied to income is the long-standing fundamental fact of that market, not a belief. That could change, however, if something about the way homes are sold changes (like having a business model based on long-term leasing come into existence which supplants ownership and allows the lessor to sell the land later for development).

That homeownership is not an investment is an erroneous belief, not a fact. Whether you want to treat ownership psychologically as an investment or not does not make it not an investment. In fact, the best way not to get burned by the burdens of buying property is to treat it as a dispassionate business transaction.

And for Tom B facing the prospect of buying into a still over-priced market, I would suggest that any house you're considering which is priced within the traditional income ratios (2.5x your income is the ideal, 3.25x income is the current average) will probably not significantly depreciate in the future and you can feel safe about buying it. If you have a much higher than average income which would warrant a more expensive than average home purchase, pay more attention also to the size and amenities of the house (have a realtor or appraiser assess its value in relation to other high-end homes in that market).

2008 Apr 30 11:51 AM

[Pent up demand:]

Malkiel,

A true investment creates wealth. The traditional "building equity" argument essentially treats the home not as a creator of wealth but as a store of wealth. Well then it's a poor one, as its value is taxed every year, it requires a substantial amount of money for maintenance every year, etc.

People make money on the sale of homes to the extent that they intentionally or unwittingly speculate on location and win.

2008 Apr 30 03:23 PM

[notsosmart:]

that has been the problem for many years.an asset gives income. a liability costs money. the roof over your head is a liability. this whole system of borrowing against rising appraised value of the roof over your head-a scam that made a lot of money for many banks etc. fortunately i did not fall for it. my house is paid off & i still treat it as an annual expense.now if i owned a second house that produced more income than expense-an asset.is this really so complicated or did so many need huge sq.footage,stone counters,hummers,etc.?

2008 May 01 08:59 AM

[billddrummer:]

Good article, good comments.

I submit that the run-up in prices we've seen that is now crashing to earth was aided and abetted by nontraditional mortgage products that permitted people to divorce themselves from the traditional mortgage lending ratios. With low rates at inception, and lenders failing to qualify borrowers at the fully indexed rates, loans were made to people that could afford the initial payments but not the later ones. As the pool of buyers grew, builders determined that more product would satisfy the seemingly unquenchable demand for new, fancier, larger homes. And with the prevailing view that 'real estate always rises' the idea was that a buyer could refinance out of the initial loan before it reset, and end up with payments only a bit higher than the teaser rate.

Clearly, the strategy stopped working when home price increases stalled. Higher than expected delinquencies on mortgage pools froze the secondary market for MBSs, and lenders responded by (wisely) tightening qualification standards. Unfortunately, those borrowers expecting to refinance were caught in an asset that wasn't appreciating, and in a lending environment that disqualified many of them from refinancing. The result of both is what we're seeing now.

When the overhang in housing inventory is worked down to a balanced level (4-6 month supply of unsold homes) the market will begin to recover. Don't expect it before then.

2008 May 01 11:48 AM

["Magazine-C...:]

Tom B -- don't search for a reason to buy a house in a declining market. If you don't absolutely need to buy for some unusual reason (you have 7 dogs, etc), then rent for a year, and give yourself plenty of time to search for that next home.

2008 May 01 04:49 PM

[Nick Gogerty:]

median income vs. median house price spreadsheet with data available nickgogerty.typepad.co...

2008 May 02 10:37 AM