The Elusive Housing “Fair Value”
Over the past few years, I have frequently referred to US housing as over priced and over valued by traditional metrics. These include:
- Median Income vs Median Home Price (mentioned yesterday)
- Ownership Costs vs Renting Costs
- Market Value of Housing as a percentage of GDP
- Housing Inventory Supply vs Sales Rates
During the Housing boom and credit bubble, prices moved several standard deviations away from the norm to extremely over bought, over valued levels. As prices have come down, these metrics are getting closer to typical levels. They remain elevated, but no longer outrageously so, as they revert back to historic means.
Those who are now calling a housing bottom (despite having done so for years) are finding comfort in this mean reversion. They shouldn’t — and for three reasons. The first is that asset classes which become wildly over-priced do not merely revert to the mean — they tend to carom straight through the mean, eventually becoming significantly under-valued. You see, if you only spend time above the mean trend line, and never below it, well then, that cannot possibly be the “mean” — the line down the middle.
Second, we know the recession plus a glut of foreclosed homes creates a “self-reinforcing cycle.” Job losses and income decreases lead to more distressed sales, with prices especially pressured. Falling prices make put mortgage holders underwater — holding homes worth less than the mortgage. This leads to walkaways, jingle mail, and even more foreclosures. All of this adds up to an even greater excess supply of homes for sale. More supply equals lower prices. The entire vicious cycle continues.
But the third issue is the biggest one of all. Its something we touched upon previously in NAR Housing Affordability Index is Worthless. None of the factors outside of price and interest rates are constructive to home sales. Outside of the $8,000 buyers tax credit, all of the rest of the factors impacting sales are deeply in the red:
1) Employment: Job losses and unemployment data remain at deep recession levels;
2) Down Payments: Surprisingly few buyers have a cash down payment of 20%. Some banks are now asking for down payments of 30%. Unless we go back to LTV of 90 and 100%, that reduces the pool of qualified mortgage applicants.
3) Debt servicing: Many mortgage applicant do not qualify in terms of 25% of monthly gross income available to pay for Mortgage Principle and Interest. This is a function of the prior debt binge — credit card, HELOC and auto.
4) Credit: As the above #3 implies, lots of potential buyers damaged their FICO credit scores in the last round of leverage; Qualifying for a prime loan is problematic for these folks;
5) Non-purchase costs: have risen dramatically. The biggest being local property taxes, and energy. The silver lining is energy prices are more reasoanble lately, and thanks tot he recession, maintenance and repair costs (especially labor) are the cheapest they have been in years.
All of these factors relate to the process of qualifying for a mortgage, and the financial wherewithal to buy a house.
The bottom line: Fair value for Housing is a concept that under normal economic circumstances is dependent upon many different factors. But during the current secular economic shift, it is even more elusive. There are an increasing number of families who might have qualified for a standard conforming mortgages in the past, but no longer can today.
And, the trend for many potential buyers is heading in the wrong direction even faster than prices are coming down. The gap between the potential home buyers and actual home buyers is not getting better, its getting worse.
We are still no way near a bottom in housing . . .
>
Previously:
NAR Housing Affordability Index is Worthless (August 13th, 2008)
http://www.ritholtz.com/blog/2008/08/nar-housing-affordability-index-is-worthless/
No Housing Recovery Before Further Price Declines (February 21st, 2009)
http://www.ritholtz.com/blog/2009/02/no-housing-recovery-before-further-declines/
Homes: Still Too Pricey to Stabilize (February 18th, 2009)
http://www.ritholtz.com/blog/2009/02/homes-still-too-pricey-to-stabilize/
NAR and Housing Forecasts (June 2007)
http://bigpicture.typepad.com/comments/2007/06/nar_and_housing.html
Tracking NAR Spin (April 2008)
http://bigpicture.typepad.com/comments/2008/04/tracking-nar-sp.html
See also:
For Housing Crisis, the End Probably Isn’t Near
DAVID LEONHARDT
NYT, April 21, 2009
http://www.nytimes.com/2009/04/22/business/economy/22leonhardt.html
April 24th, 2009 at 7:37 am
BR Posts:
“2) Down Payments: Surprisingly few buyers have a cash down payment of 20%. Unless we go back to LTV of 90 and 100%, that reduces the pool of qualified mortgage applicants.”
Barry- what you are missing is that FHA limits have been increased to $729,750- which only requires a 3.5% down payment- which can be all gifted by the way- the people buying homes right now aren’t putting any money down unless they are substantially over the $729,750 limit on Sale Price- this all thanks to the USG.
April 24th, 2009 at 7:45 am
Did you happen to miss the fact that incomes have been negative in real terms for over a decade? I find that the biggest problem facing the WORLD is that the politicians, pundits, and other none thinking people, always suggest that we have to created more skilled jobs, which means that less labor is needed, but the increases in populations, equal bigger labor forces with fewer jobs available. So how is educating more people to be higher skilled, going to solve the problem?
April 24th, 2009 at 7:51 am
It appears that Chrysler is going down w/ or w/o Fiat- from the WSJ: (check out the 2nd paragraph)
“Chrysler LLC is preparing to file for Chapter 11 bankruptcy protection as soon as next week, whether or not it reaches a deal with its lenders or forges an alliance with Fiat SpA, said several people familiar with the matter.
If an agreement with the car maker’s lenders can be reached, Chrysler would file for bankruptcy protection to rid itself of some liabilities. That would let Fiat pick and choose which operations it wants, these people said. The U.S. government would provide bankruptcy financing while the reorganization plays out.
The United Auto Workers union is on board with the plan …”
April 24th, 2009 at 7:59 am
BR,
Nice post. I thought Grantham had once said that he studied all bubbles and all or almost all of them instead of reverting to the mean tend to go back to a starting point. I could be wrong about the specifics of what he said but pretty close. In any event, we aren’t at the bottom in housing.
In my area, I have finally started to see home prices really drop. The main drops are in houses that were going for 600k or more. Below that and it seems home values are staying pretty sticky…at least where I’m at.
April 24th, 2009 at 8:00 am
Good morning fellow nattering nabobs of negativism…
and you Franklin, you parroting pollyanna of positivism…
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_reilly&sid=aColIYAe.RaU
Fannie Mae Creates Housing Mirage With Bum Loans: David Reilly
“Faced with growing numbers of homeowners unable to make mortgage payments, Fannie decided to fund loans to borrowers that were instant losers.
The point was to buy time. Even though those loans resulted in a $453 million loss, they helped keep troubled homeowners from defaulting. That meant Fannie for now didn’t have to make good on loan guarantees that may have cost it as much as $2.4 billion.”
Oh,well….
April 24th, 2009 at 8:03 am
In general I agree with your statements 100%. Although you cannot know the specifics of what is going to happen the list provided will give you a general idea of what to look for and more often than not is sufficient to keep you out of trouble. However, my question is why does the media and the “exerts”‘ not know or understand this, or at least not publicly acknowledge these facts. In general it makes the media look like a bunch of idiots usually and they tend to revert to economic yellow journalism and completely miss the point.
April 24th, 2009 at 8:15 am
Would love to hear the thoughts of readers here on the value of Zillow and its pricing matrix of homes. It seems to be as close to “real-time” pricing as I can find, but I do not fully understand the inputs or how they arrive at a fair-market-value.
Having been a leasee the last 4 years, I am interested in buying this summer if I can find the right deal. Thoughts anyone?
April 24th, 2009 at 8:18 am
There is also the mental and attitude side of the story as well. There needs to be a return (if possible) to the quaint (but true) idea that a home is to live in – it’s not an investment per se. Investments are stocks, bonds, CD’s, etc. A home is where one lives, raises a family and goes to after work (or should at least).
One often forgotten point of this whole mess is the very attitude that a home is a “investment”. The idea that ones home will increase in value every month or year and something that we can flip, sell, HELOC or second mortgage. True wealth building for most people must return to old-fashioned saving and investing, not relying on selling ones home for retirement monies.
April 24th, 2009 at 8:21 am
Betting on a stock market reversion to the mean in 2003 was a huge money-loser.
~~~
BR: You have it backwards — the mean reversion bet was made in 2000.
That was not a loser . . .
April 24th, 2009 at 8:23 am
@phb
Re: Zillow,
I talked with an FA yesterday that works for a firm that has a lending unit. He had a client refi in New Castle, DE. Zillow had the house listed as $240k, the appraisal came back at $290k. This was just yesterday so it’s the most recent example I can think of.
April 24th, 2009 at 9:08 am
When I look at the calculated risk graph that you posted yesterday I would say that we are at least 2/3 if not 3/4 of the way down to the buttom of on a U-L curve (Unbelivable-Long way back up). The big Y-O-Y falls started in June 06 and lasted to August 08. After that only one month (Nov. 08) have had a real substantial Y-O-Y fall in sales. I would also not discount the possibility that government look at these numbers and would intervene if one of those negative things start driving sales substantially down again. They are the masters of F&F now so they could tell them to lighten up. Another thing that may help stabilizing prices is that we finally have killed supply of new houses.
April 24th, 2009 at 9:09 am
Excellent analysis, BR. Meanwhile Steve Leisman is on hawking the government stress test info to come out this afternoon. I wonder how much creativity will be divulged as to how the banks pass the stress tests? How long until they come for the taxpayer’s pocketbook again????
April 24th, 2009 at 9:29 am
Thanks, Barry. I won’t even consider buying my first house until prices are below the mean and Obama gets desperate for re-election–of himelf and his Congressional majority. (Then we’ll see some real government incentives for buyers!) I figure this convergence for the Spring of 2012. As austincompany astutely pointed out above, a lot of this is mental. I’m waiting for the Boomers to finally give up and decide to “age in place.” Then I’ll be able to afford something. I will not help them paper over their lack of retirement planning by paying their extortionistic housing prices. Also, we’ve got a lot of sorting out to do as to which neighborhoods are going to come out of this better than others. Sure, a $30K one-bedroom condo in Boca sounds good, but where is that neighborhood headed over the long run? I don’t like the smell of it. Until then, I’d rather rent where I want to live than “own” somewhere I don’t.
~~~
BR: Just remember when you do the math, the money you pay for rent is gone.
A $2,000 and a $2,000 rental are not the equivalent. There is the tax benefit of the mortgage, versus the risk of home depreciation.
So if you buy a house today and it loses $50,000, in value, but your rent would have been $2,000 per month ($48,000 over 2 years), the difference is only $2,000 — but you are ahead in terms of taxes . . .
April 24th, 2009 at 9:35 am
Durable goods previous numbers for each month were revised lower. I like to exclude transportation and defense to see what the consumer is doing (Feb-Mar change is -1.74% and the previous month was 8.13%). Y/o/y went from -5.31% in Mar 08 to -1.74% in Mar 09 so a slight improvement (still negative though).
April 24th, 2009 at 9:42 am
Something to keep in mind is that “the larger the volume, the longer the wavelength”. So it might well take longer than anyone expects for housing prices to undershoot the mean before returning to it.
The second derivative can take a very long time turning positive, and remaining only mildly positive will allow the first derivative to sloooowwly bottom out. We mere mortals tend to project things into our oh-so-finite life expectancies, and these changes that go on for large fractions of a lifetime (possibly fractions greater than 1), thwart those expectations most rudely.
OTOH, it seems likely that the population will continue to increase, with our aging demographic being countered by a slide down the economic ladder towards impoverished banana-republicanism (lower income populations tend to be more fecund than wealthy, aged populations), so there is a likely mechanism to eventually push housing prices higher.
Just a question of when “eventually” is.
April 24th, 2009 at 9:46 am
@phb at 8:15 am
“Having been a leasee the last 4 years, I am interested in buying this summer if I can find the right deal. Thoughts anyone?
If you feel compelled to buy this year and/or find your dream house, consider a 1-year (or longer) lease/option-to-buy which will give you flexibility regardless whether prices go up or down in 2010 (or later)
April 24th, 2009 at 9:52 am
@ahab: That’s true but I’m already hearing of increasing FHA defaults. Don’t you think that’s merely another bomb ready to go off down the road?
April 24th, 2009 at 9:57 am
From the same article Bruce N Tennessee cited:
“In the meantime, Fannie is simply burning taxpayer dollars to create a housing smoke-screen. ”
Change “Fannie” to “the US Treasury/Federal Reserve” and you have succinctly described what is going on in the housing market.
Then this:
April 24 (Bloomberg) — The U.S. Treasury Department is preparing a bankruptcy filing for Chrysler LLC only as a matter of “due diligence,” Michigan Senator Debbie Stabenow said in an interview.
“They are preparing all options,” Stabenow, a Democrat, said yesterday in Washington. The senator said she was told April 22 the filing was being readied.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aZkI.iOe4_us&refer=home
What the hell has happened to my country? When did the US Treasury begin preparing bankruptcy filings? We won the Cold War so we could emulate and reinvigorate the idea that all wealth is owned, created and destroyed by the central government?
I think Texas Governor Rick Perry may have let slip some truth. If this continues apace, the next best option might be secession, or something like it, again.
While I don’t know what the best option might be, I do know this: Once all power devolves to Washington, as it rapidly is doing, it will take a revolution of some sort to wretch away the power thus grabbed. Washington won’t be interested in freely relinquishing it. It sickens me to realize that we’ve sheepishly yielded so many freedoms (including the freedom to fail) on the mere threat of hard times, that really aren’t, but are only just a bit less easy times than they were before.
April 24th, 2009 at 10:04 am
The free paper in the subway this morning says Manhattan real estate now marked down an average of 14% or ~$300K from the average of ~$2.4M. There is going to be some real pain in Gotham before the elusive “fair value” of housing is determined. As Vin Scully used to say: “pull up a chair, we’re just getting started…”
April 24th, 2009 at 10:10 am
Yesterday’s NYT story about “Slump Creates Lack of Mobility for Americans” is a timely read. Real estate’s poor liquidity in downturns was all but forgotten in 04 & 05. National metrics aside, the same way many hot zones led the parade up, the same is happening in reverse. Detroit is up to bull dozing neighborhoods. This won’t be the only time that option gets discussed or done. Think many young adults will be greedy for real estate after these stories? Calling a bottom anytime soon is very misguided.
April 24th, 2009 at 10:16 am
I think the real bottom in real estate finally happens when their is true revulsion to real estate. We’re not there yet. That’s obvious. Too many out there now looking to get in on the game they think they missed during this latest run up. What they don’t realize is that game is over and not starting up again.
April 24th, 2009 at 10:25 am
I’ve said this here before and I’ll just have to say it again since we’re on the same topic. Why do we assume that folks are going to use the same % of their income for shelter that they have in the past? Spending habits change over time. There is nothing magical about 25% of income or 32% of income or any other metric for what % of a budget shelter should account. We have changed our consumption much more substantially in other areas like Medical Care yet I see no one talking about a huge Medical Care bubble that will burst. Go to BLS and see that shelter has gone from an index of 27 in 1967 to 248 today while Medical Care has gone from 27 to 370. http://data.bls.gov/PDQ/outside.jsp?survey=cu
The price/rent ratio makes much more sense but that too can be greatly skewed over the decades by changes in interest rates, tax laws, etc.
I’m no bubble denier, I started reading and commenting on calculated risk and the housingbubbleblog back in 2004 before bubbles were cool. But, I think folks looking to call the bottom by historical metrics without accounting for the fact that tastes and preferences change in how families spend money and those are heavily influenced by interest rates and tax benefits may be quite mistaken. I’m willing to bet that prices bottom in the Washington DC area where I live this year and I suspect the rest of the country won’t be far behind.
April 24th, 2009 at 10:47 am
I bought my first house in Montreal in 1995. That was 4 years after the last mini bubble burst in 1990-1991 and the year of the referendum. The mood toward real could not be lower!
The way I saw it was that I could pick up a house for 65$ per square foot and the land came for free. For a value investor like me, it was a no brainer if you ask me.
When we were window shopping and looking at listings in a shopping center, this 50 year old guy came up to us and told us to avoid real estate. The worst investment you could ever make. He told us to rent and travel.
When I hear those words again, I’ll know we’ve bottomed. It took at least 4 years and the bubble was not even a bubble by today’s standards.
Too many people still dipping their toes for a true bottom.
April 24th, 2009 at 10:48 am
first off, “mean reversion” is a form of statistical generalization about the reproducible effect of signal and the nonreproducible effect of noise (random error). “mean reversion” is not an economic or market process, in the same way that “volatility” is not risk. reifying a statistic like beta is not an analysis, it is incantation. if a descriptive statistic changes, then the reason for it has to do with what you are measuring, not with the statistic. focus on and explain what you are measuring.
to be contrarian, i think the velocity of the national housing decline will abate significantly by this summer. the interactive chart posted at NY Times shows many markets have returned to recent historical levels on the chase shiller index. there very likely must be a reset downward from those levels, but a home is a very different type of investment from paper promises, and there is still a huge amount of cash on the sidelines.
i don’t think job loss and the economy are the main story about buyers; lender terms (credit availability) and job retention have a lot to do with it (fewer people now are relocating to new jobs). more important, the national statistics disguise the processes of recovery in local markets, which will start to stabilize in the midwest and atlantic first and in places like california last. even so, prices in my area — sonoma county, california — prices have stopped declining and the rate of sales has increased.
April 24th, 2009 at 11:13 am
The perspective from the West Coast is clearly different. It’s true that some aspects of the recession may appear to end sooner in places like Sonoma County than in NYC where the housing market is only just beginning to pop now. But the big question is: what about the second wave of problems, notably in the higher end of the market caused by lingering unemployment and a long overhang of housing supply? Don’t forget rising taxes in CA.
April 24th, 2009 at 12:19 pm
Curmopdgeon @ 9:57
Washington is the people. What is so wrong with all power to the people? Nobody in Washington keep their power if more than 50% of the people decide that they shall not continue to have it. Wall street on the other hand was never elected and has always served and only answered to the rich. They were allowed to do that with the understanding that somehow that would actually also serve the people. After that illusion have been so completely destroyed it is only natural and about time that we stick it up wall streets a$$ and drown their power. All power to the people.
April 24th, 2009 at 1:45 pm
I agree with everything in the post except the part about 20% down payments. FHA loans are still at 3.5% down and conventional loans are at 5% down in my area in Indiana. In areas where prices are still dropping quickly I can see why lenders would want a larger down payment, but not sure how common this is overall. Maybe others on this board know what minimum down payments are in their areas?
The basic premise of the article is still on target, though. A lot of buyers can’t even come up with 3.5% down. They became accustomed to being able to buy a house with 0% down with the seller paying all closing costs. They could formerly walk into a property without one red cent out of pocket – ridiculous!
April 26th, 2009 at 9:43 pm
In my column today, I argued that the results from some recent house auctions suggested the bottom of the real-estate cycle is still a ways off. One of the more interesting pieces of evidence that I found — but didn’t have room to include — was the average winning bid at house auctions in Miami over the last year-and-a-half.
I calculated these averages based on data from the Real Estate Disposition Corporation, which ran the auctions:
Auction month Average winning bid
Dec. 2007 $209,000
April 2008 $180,000
July, 2008 $162,000
Sept. 2008 $145,000
Dec. 2008 $114,000
Feb. 2009 $105,000
April 2009 $94,000
For the last year, the average sale price has been falling by roughly 4 percent a month. The rate of decline hasn’t tailed off.
This is just one small batch of data, obviously, but it’s consistent with the larger picture. Given the huge supply of unsold homes and the fact that houses remain expensive (relative to incomes or rents) in some big metropolitan areas, prices in some places still have a ways to fall.
April 27th, 2009 at 10:49 am
This is the classic “bear trap” where you get a temporary pause in a market collapse that pulls in people thinking its all over only to see it continue a precipitous fall. Its like that scene in Titanic where the ship slowly sinks but then levels off when the submerged part of the boat (partially) breaks away. Everyone is relieved that they are floating level when all of a sudden they get pulled down in a rush to the bottom. The sinking part of the housing market (and economy) just (partially) broke away.
We are no way near a bottom and housing will get another kick in the pants in two years when interest rates have to start going up again (to combat inflation from all this money being printed and flushed down the economy). Everything will get a shorter term kick when we finally have a large bank failure (3-6 months) (my guess is it will be Bank of America)
See the Titanic analogy here:
http://invisiblerenters.com/2009/03/29/rearranging-deck-chairs-on-the-peninsula/
There is also a nice chart that shows how, much to everyone’s surprise, the housing market CAN behave EXACTLY like the stock market.
April 27th, 2009 at 12:22 pm
Intrigued by “drollere – April 24th, 2009 at 10:48 am
Quite interesting to have the terminology of statistics parsed again. But none of that takes into account the cascading aspects of where this economy is going and housing only being an element of that. This vicious cycle that we are on encompasses trillions of dollars worth of resetting mortgages going forward without any break, even accelerating into mid 2012. During that time there will no doubt be many periods of boom and bust, all on a downward trend. As people become increasingly averse to spending, as government prints money hand over fist, giving us rampant inflation, housing values won’t support the amounts needed to refinance or sell. Banks will be stuck with an increasing inventory (much of which is not being put on the market NOW in an effort to not undermine the prices of what is there now) of property which cuts directly into their bottom lines. Thus, a further cascading of bank failures. As credit is squeezed further, spending will continue to winnow to the necessities and away from the massive variety of luxuries that we have become accustomed to. This will compound job losses as well as imports which by extention will decrease exports because the markets for our domestically produced goods are driven by our appetite for the foreign produced products. VICIOUS VICIOUS cycle.
‘drollere’ amuses me as someone with a great deal of technical understanding of a topic who has no practical grasp of DYNAMIC economics.
For anyone interested in purchasing a property, the most interim point of reference should be the year 2012. Of course, that is a presidential election year and the ability of the powers that be to manipulate the economy up to that point is a very strong consideration. That pushes my timeline WELL into 2013 at which point the weight of any manipulation will be so heavy that a lame-duck second term administration will have much less incentive to move the shells around to keep a positive spin on the economy OR the NEW administration is motivated to call a spade a spade and begin to allow the chips to fall where they may and have values find their natural levels.
Unless I was completely comfortable with a property that I purchased being worth half what I paid for it and the prospect of not being able to either refinance it OR sell it anytime within the forseeable future, I would find a way to rent, even in the Dallas market where I live where we are experiencing the LEAST of the implications (so far).
April 29th, 2009 at 9:25 am
[...] will these prices level off? When people believe that they can purchase a house for such a great price, that it overcomes their [...]