What to Expect from House Prices

I feel a little silly doing this, but it seems like I need to make that case that house prices are important.

You might recall that the Great Recession started with a fall in house prices. A mountain range of bad mortgages and the bonds that they were packaged into got most of the attention, but let’s remember that the whole sub-prime accident-waiting-to-happen wouldn’t have existed without a decade long run up in house prices. And if that run up had by some miracle continued, the accident would be still waiting. (And getting worse.)

But even if American house prices hadn’t recently been the rug that got pulled out from under the global economy, it’s a topic of huge importance in the world of personal finance. More than two thirds of American households own the place that they live in. For nearly all those households, the house is the largest single asset and one bought with mostly borrowed money.

(By the way, if you are thinking that the two-thirds owning homes is a result of recent and possibly regrettable government policy, you’d be wrong. It’s been in that ballpark for a long time. It was 68.9% in 2005, all the way up from 62.1% in 1960. And a lot of that 6.8% increase was mere demographics, e.g. the Baby Boomers got married and bought a place in the burbs.)

So how come I seem to be the only one obsessed with house prices? I’ll admit that the US house market is not as volatile or as interesting as a spectator sport as the US stock market. But the two markets are roughly the same size and have a similar importance to the economy. And the stock market has entire cable TV networks devoted to it.

The media does cover the housing market, but not all that well. To be fair, it often seems like they spend more time and ink on house prices than their viewers and readers really want. As shallow as the reporting is, I get the impression nobody is listening.

Last weekend Brett Arends ran a piece on the Wall Street Journal on the beginnings of a recovery in house prices. Towards the top he discussed the fact that the Case Shiller 20 City Composite was down only –0.2% in May. Except that it was up 0.45% in May. (I think he meant the rarely cited seasonally adjusted version of the index, which was, in fact, down –0.159%, and which a non-obsessed person might round to –0.2%.) Of the 29 comments on the article posted by Wednesday, how many do you think mentioned this inconsistency? Not a one. Imagine what would have happened if he had gotten the direction of the monthly return of the S&P 500 wrong.

The rest of the article is about how although house prices may have stopped their long march downward, you shouldn’t expect a sudden V-shaped recovery. I basically agree, although I do remember all us sober types saying the same thing about the stock market just before it went up 50% in a head-jerking hurry.

In the short term, the next 12 months or so, I expect something like we’ve seen very recently, with modest increases in most of the country balanced out by continued problems in South Florida and the Southwest. But short term predictions, while fun (particularly for those who get to mock me next year when I turn out to be wrong) aren’t particularly useful.

For most folks, what is important is the long-term outlook, what to expect for the years and even decades to come. Most households will wind up owning the roof over their head. But how much roof they buy, and the plans they make for how they spend and save the rest of their income have a lot to do with what they expect to happen to the value of that roof in the long run.

As I wrote back in February (in what is still one of my favorite posts) I expect house prices to track inflation over long periods. Maybe a tad more in places with vibrant economies and nowhere to build more houses (e.g. New York, Boston, San Francisco) and maybe a tad less in places with challenging prospects and/or an inexhaustible supply of house lots (Detroit, Las Vegas.)

But the basic story is that houses track inflation, i.e., they hold their value in real terms, assuming you pour money into them to keep them maintained and up to date. I’m not going to answer the philosophical question of whether or not houses are an investment. It is possible to get rich from the house you live in, but not very likely.

Owning a house often (but not always) makes sense because it is the most cost-effective and satisfying way to buy shelter for you and your family. Buying more house than you need as shelter because you expect to sell it later on at a profit is generally a poor idea. But so is buying less because you fear selling at a loss.

Housing, Media | Frank Curmudgeon | August 20, 2009 8:00 am

No Comments

By The Incidental Economist, August 20, 2009 @ 9:01 am

Two quick comments/questions:

(1) Did the run up in home prices feed the MBS craze or did the financial innovations and a glut of money in search of return drive the run up in home prices (via relaxation of lending standards)? I’m inclined to believe the latter.

(2) Does the baby boom really explain the increased rate of home ownership? This is empirically testable. Annual data on home ownership rate, demographics, economic factors, and policy initiatives are all easy to come by.

In fact, the research on this has been done, and published. Here is just one article (of many): http://www.jstor.org/pss/2061523

Maybe I’ll blog on this literature. It’s now in my queue. Can’t say when I’ll get to it.
By Rick Francis, August 20, 2009 @ 10:34 am

>So how come I seem to be the only one obsessed with house prices?

I suspect because housing prices rarely matter to most people- when they buy, when they sell and if they refinance. For most people that is going to be once ever few years to once in a large number of years.

Even a home speculator that buys and sells more frequently cannot immediately sell a home- like a stock speculator could sell a stock. They could put it on the market but finding a buyer could take months.

Not to mention the important housing prices are the local ones. Any interest I have in housing prices is really going to be housing prices in my current neighborhood and the neighborhood I would move into.

-Rick Francis
By Frank Curmudgeon, August 20, 2009 @ 10:56 am

Incidental: 1) MBS innovations are actually rather old. Clearly, the glut of money available for financing houses and the run up in prices reinforced each other. House prices went up becuase financing was easy to come by and it was easy to come by becuase house prices seemed to always go up.

2) I’m actually not up on the literature on this one. I do remember reading something in what seems like an eon ago that debunked the idea that increased home ownership was something the Republican Adminstration could take credit for. The point is that the increase in the past 50 years is a lot smaller than most people assume and not some great big recent change in how we live. The Baby Boomers getting to house-owning age was just an example of what I think are many drivers of the change that are neither government policy nor a pure question of money. I look forward to the complete discussion of the topic on your blog.

Rick Francis: You make a good point that people buy/sell houses mostly for non-economic reasons and so are less obsessed about the economics than they could be. I guess I’m not entirely convinced this is a good thing. There’s a lot of money involved.
By Kent @ The Financial Philosopher, August 20, 2009 @ 11:07 am

I tend to agree with your forecast with regard to mild stability but continued weakness in a few areas of the US.

Now that extreme pessimism and wildly irrational behavior appear to be dissipating, logic has a practical use.

My logical (and mostly anecdotal) view is that there remains a significant number of Americans “waiting out” the recession to place their homes for sale.

As home values begin to modestly rise, the 1/3 of home-owners that are currently “underwater” will approach the “break even” point and begin looking at making the move to cities where they can find employment.

In other words, another “wave” of home-sellers is around the corner that likely won’t be met by an equally powerful wave of home-buyers.

Furthermore, federal stimulus will end this year and interest rates will soon begin to rise, making for a “double-whammy” of downward pressure on home values.

Thanks for the logical perspective and for provoking thought…

Kent @ The Financial Philosopher
By gpr, August 20, 2009 @ 11:28 am

I didn’t think the problem was an increase in the percentage of people who owned homes, but rather an increase in the percentage who owned homes too expensive for their circumstances.
By My Journey, August 20, 2009 @ 11:49 am

Great point GPR. While the American family keeps getting smaller the home keeps getting bigger (causing it to be more expensive):

http://www.zillow.com/blog/images/householdandhomesizegraph2.gif
By Mark Arsenal, August 20, 2009 @ 12:47 pm

“As shallow as the reporting is, I get the impression nobody is listening.”

Probably because no one feels that the housing market is quite as liquid as the stock market, and thus it doesn’t feel as “real” to most average people in their budgets. To most people it’s not an “investment” but a “cost”.

Of course, the recent economic bust was largely the result of ill-conceived attempts at MAKING that market be more liquid for the average person…

“But so is buying less because you fear selling at a loss.”

What about buying less because everyone else’s concept of “less” is too high?
By Jim, August 20, 2009 @ 1:49 pm

I agree that we’ll likely see home appreciation longer term that is at the rate of inflation. Appreciation will vary based on region too and likely be +/- 1-2% from inflation depending on general region.

The aging of the baby boomers did have a big impact on the home ownership %. From 1990 to 2005 the homeownership rate went from 63.9% to 68.9%. Thats a 5% increase in 15 years. Over half of that increase was due to people in the ages 45-65 growing in number. While ownership in that group only went up from 77% to 78.5%, they represented more of the population and that drove up the overall average more.

The aging of the population as a whole also increased homeownership rates. People over 65 years old own homes more often with rates around 80%. That age group grew 2x as fast as the population as a whole from 1960 to 2000. So this would drive up the overall homeownership rate ~1% or so.
By gpr, August 20, 2009 @ 5:24 pm

Frank, I re-read this post and am confused.

If house prices will more-or-less track inflation, and people will more-or-less buy as much home as they can afford, what real estate news would you like to see reported? What should I, as a home owner, be interested in knowing?

But how much roof they buy, and the plans they make for how they spend and save the rest of their income have a lot to do with what they expect to happen to the value of that roof in the long run.

Is this true? My plans for how much to spend on a house are based not on a percentage of my current income, but on what I think will happen to the value of the home? If this is true, is this not silly?
By Mr. ToughMoneyLove, August 20, 2009 @ 5:30 pm

I disagree with you on the relationship between home ownership rates and bad government policy. From 1960 to 1990, homeownership creeped from 62.1% to 63.9%. However, from 1990 to 2004, it escalated to 69%. That’s statistically huge. Prior to that 2004 peak, Bush introduced both the American Dream Downpayment Act (to help broke buyers get their house anyway) and the Zero Downpayment Initiative (to allow FHA to insure mortgages for first time homebuyers with no down payment) It was all ridiculously high risk and clearly contributed to the avalanche of foreclosures we are now experiencing. I wrote all about this months ago.
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