Ever since the Great Debacle of 2007-08, we have all had house prices on our minds. Other topics may be grabbing headlines, but there has always been a recurring interest in how the old US residential market is doing. And there are good reasons for that. Not only is it a massive asset class, representing a sizeable portion of our national wealth, but for many families the house is the single biggest asset, often exceeding the value of the household’s net worth. And housing is, after all, where this whole nasty economic mess started.
Lately the house theme has been about whether now is the time to jump in and buy. Two days ago Time decided to share Why This May Be the Ideal Time to Buy Real Estate. That echoes the sentiments at such places as MSNMoney and The Simple Dollar. And even celebrity rich guys as diverse as Warren Buffet and Donald Trump are in on this one.
Skeptical cynic that I am, my first instincts are always that popular trends are probably wrong, and that goes double if The Donald is involved. But I long ago learned to discount my instincts when it comes to big money issues.
The argument in favor of buying a house now is simple and appealing. Prices are relatively low and when mortgage rates are factored in, houses are just plain cheap. This, it should be pointed out, is a much sounder argument than what you might have heard in favor of houses seven or eight years ago, that however expensive they were, now was a good time to buy because they were set to become even more expensive soon.
But just how cheap are houses? According to the Case-Shiller 10 city composite, prices are down 35% from the June 2006 peak. That is encouraging, but it just means that prices are back to where they were in April ‘03. In other words, it could be argued that all that has happened is that we have returned to normal and that prices are not particularly low or high now.
Fair enough. But the actual cost facing most consumers, and the number that would rationally be compared to rent, is the monthly mortgage payment that would be due if they bought. So the salient question is not how cheap houses are now in terms of raw prices, but in terms of mortgage interest payments.
To get at that, I hereby launch the BMA House Cost Index. It aims to measure the real cost of real estate, rather than the price. (Or affordability.) The formula is pretty simple. I start with the good old Case-Shiller 10 city, which goes back to January 1987, and adjust it for inflation using the CPI. I then multiply that number by the average 30-year fixed mortgage rate as reported by Freddie Mac.
The index is scaled to show what it currently costs to pay the interest for a year, in 1987 dollars, on what was $100,000 worth of house in January 1987.
The current reading (which is for February 2012, the latest data point from Case-Shiller) of the BMA HCI is $4479, meaning that it now costs $4479 a year in 1987 dollars to float what was $100,000 worth of real estate back in 1987. That is down from a peak of $13,479 in July 2006, a drop of 67%. And the current value is now just over half the average value since 1987 of $8814.
There is really no escaping the fact, illustrated in the chart above, that houses are now cheaper than they have been in a generation.
Of course, like any index this is a simplification of a complex picture. The Case-Shiller 10-city composite is just a national average that may not accurately reflect reality in your local area or for any particular house. The index does not consider tax effects. Or the availability of mortgages. Or the inflation dividend you get from owning a house. But I think it gets the big picture right.
Other than the low current reading, the most interesting observation to be made from this chart is how ordinary the great house price bubble of ‘03-‘06 looks. As crazy as prices may have gotten in the middle of last decade, in terms of real mortgage payments, what consumers were actually paying monthly in real terms, house costs were actually roughly in-line with what happened in the late 1980s. (And might be similar to many other periods for which we lack data.)
So, in as much as houses really are cheaper than they have been in at least a quarter century, and possibly much longer, popular opinion seems to be on target. However, wet blankets like me need to point out that as cheap as houses are today, there is no law that says that they cannot get even cheaper tomorrow. All we can say is that this is a good time to buy a house, not that it will be someday looked back on as the best time.