Housing in 2011: Will Prices Fall Further?

Includes: IYR, REZ, XHB
by: NewstraderFX

Nouriel Roubini and Peter Schiff recently posted articles suggesting that housing prices will fall by another 20% (see here and here). My suggestion is that whether this is correct or not is likely to have very much to do with inflation because as you will see:

  1. The real, median price is above historical levels
  2. If the Fed creates a higher inflation rate, as they apparently are trying to do, real prices in most areas are likely to fall even if they rise nominally.

According to the latest Case Shiller HPI report:

The S&P/Case-ShillerHome Price Indices for October showed a deceleration in the annual growth rates in 18 of the 20 MSAs and the 10- and 20-City Composites in October compared to what was reported for September 2010.

The 10-City Composite was up only 0.2% and the 20-City Composite fell 0.8% from their levels in October 2009. Home prices decreased in all 20 MSAs and both Composites in October from their September levels.

In October, only the 10-City Composite and four MSAs – Los Angeles, San Diego, San Francisco and Washington DC – showed year-over-year gains. While the composite housing prices are still above their spring 2009 lows, six markets – Atlanta,Charlotte, Miami, Portland (OR), Seattle and Tampa – hit their lowest levels since home prices started to fall in 2006 and 2007, meaning that average home prices in those markets have fallen beyond the recent lows seen in most other markets in the spring of 2009.

As the chart below shows, the median price when adjusted for CPI is still well above the historical range, suggesting that the real median price still needs to decline if the nominal gains made as a result of the housing bubble are to fully retrace.


What also is interesting about this chart is that it shows how steady the real median price was for over 50 years. Except to two periods in the early 1980′s and 1990′s (which adjusted back both times), from about 1947 until about 2000 the rise in nominal prices was almost entirely due to inflation alone.This is true because in order for real prices to remain constant, the percentage increase in nominal prices must be offset by the inflation rate.

The S&P CS HPI is indexed (year 2000 = 100) but price changes are reported on a nominal basis. The 10 city and 20 city indices are currently 159.03 and 145.32 respectively, meaning that prices are up 59.03% and 45.32% since 2000 before inflation. In CPI terms, the dollar's purchasing power has declined by 21.3% since 2000 ($100 today buys only $78.70 then). So, adjusted for inflation, the indices are up 37.7% and 24% respectively.

Taking inflation into account, when looking at each city's current index, a reading equal to 121.3 means that prices have exactly kept up with inflation since 2000.

Of the 30 cities making up both indices, 6 are currently below that level. Detroit has the lowest index at 68.86, meaning the nominal price is now 31.14% below where it was in 2000. But in real terms, price has declined by 52.4% since then (and obvioulsy by a much larger amount off the 2007 peak).

Minneapolis is exactly even with inflation and the remaining 23 are above. D.C. leads the way here, with prices up 86.67% nominally and by 65.37% in real terms.

So the question now is, what might happen going forward? The answer to that lies in part with how successful the Fed will be in its quest to create a higher inflation rate. If the overall median price is to return to its historical (pre-bubble) norm, any nominal price increases must be offset by a higher rate of inflation.

The 10 city composite had a nominal 0.2% YoY increase in Ocotober but in real terms, there was a 1% decline (October's unadjusted CPI-U was 1.2%). For the 20 city composite, the real YoY decline was 2%. Just 4 markets (D.C., L.A.,San Diego and San Francisco) had nominal increases greater than CPI, meaning they experienced real appreciation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.