All this week, we will be looking at the Housing Recovery meme, challenging the assumptions and data that make up that argument. Monday, we began with Debunking the Housing Recovery Story. Yesterday, we did a Reality Check on Home Affordability.

Today, we take a closer look at pricing — where we are, and how much lower we have to go.


According to the Case Shiller index of national prices, the median price of a home in the United States has fallen ~35% from peak price to trough. Very few folks had forecast this.1

Some regions that were excessively frothy during the boom — California, Las Vegas, South Florida and Arizona — have seen much greater price drops. Other areas had laws (Texas) or other financial conventions (New York City) that mandated significant down payments and other prudent requirements avoided much of the bloodshed. These regions did not see the same speculative silliness to the upside and hence have been spared the madness to the downside.

Where are we today? Where might prices go over the next few years? The conventional wisdom seems to be that prices have stabilized, and that we might scrape along the bottom for a few more quarters or even years. The data suggests something else.

Let’s begin with current prices: The most recent Case Shiller index of national prices (January 2012) reveals that prices are still falling, about 4% year over year. We can point to three favorable data points regarding home prices:

1. Prices are decelerating, falling more slowly than they had been circa 2007-10;

2. Prices are now back to where they were in 2003;

3. The median prices comparing Rentals vs. Home Purchases now slightly favor purchases.

These may not sound like terrific progress, but they are a marked improvement over what was taking place a mere three years ago. And while we still have government intervention in the form of Mortgage Mods (HAMP) and Foreclosure Abatements, we are no longer seeing distortions of First time buyer tax credits.

We will spend some time on the Psychology of Renting later this week (including Mortgage rates) but for now, let’s simply note that rental pricing has dramatically accelerated. As the chart (courtesy of Ned Davis Research) shows, costs of owning vs renting are now back to where they were in 1997, 1988 and 1976. The context is obviously very different today; However, this is the metric of choice to employ to show homes as not expensive:


Home Price Appreciation/Rent



While rentals look less appealing as they go up in price, the other side of the equation is simple mean reversion. By most other metrics, home prices have almost but not quite fully mean reverted. That raises two important problems: Valuation and Post Bubble Pricing Behavior.

Yesterday, we discussed crucial purchase impediments such as having a 20% down payment, and qualifying for a mortgage. The next chart (again courtesy of Ned Davis Research) shows the historic relationship between median income and median purchase price. This is yet another crucial factor, as any buyer must earn sufficient income to service their mortgage obligations if they hope to keep the house.

And therein lies the rub: Real Incomes have been mostly flat the past decade; this is making it challenging to grow into a full blown housing recovery. Without real income growth, the purchasing power of potential buyers remains flat.


New Home Price/Median Household Income


The relationship between income and purchase prices has been very stable. As the above chart reveals, home prices relative to income (and therefor purchasing ability) have come back down nearly to the way to the mean. That uptick that we see in 2009-10 was based on the First time buyer tax credit. Once that expired, the downward price action began anew.

By this very basic and traditional measure of home prices, we can determine that prices remain slightly elevated relative to where they have historically been. The variable is always mortgage rates, which we will address later this week as well. However, we must consider that the ZIRP policy of the Fed is keeping mortgage rates at unprecedentedly low levels. This helps explain most of the slowing of the mean reversion.


Post Bubble Pricing Behavior

There is one last factor that requires some discussion: How asset prices behave following a bubble.

Regardless of the asset class — stocks, bonds, commodities, homes, etc. — assets do not merely mean revert. We have never seen a stock market that has run up into bubble territory, and then merely reverted to fair value of a 15 P/E. Instead, we careen wildly past that level, to deeply undersold, and exceedingly single digit P/E cheap.

That is the marvelous mechanism of markets. It is how assets are repriced, distressed holdings liquidated, capital markets stabilized, fools revealed, speculators punished — and money finally returned to its rightful owner, the prudent investor.

To date, we have not fully mean reverted, much less fallen far below fair value. In order to form a lasting recovery, we need to see homes cheap enough that they fall into “good hands” — i.e., long term owners who can afford to make their monthly mortgage payments.

Until that happens, homes will continue stumbling along the bottom of the price range, with a negative bias to prices. Another 5-10% is a very easy downside target — assuming nothing else goes wrong . . .


Tomorrow: Foreclosures!


1. See Reinhard & Rogoff, January 2008, Ritholtz, May 2005).

Category: Markets, Real Estate, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

30 Responses to “The Problem With Home Prices (Part 3 of 5)”

  1. Petey Wheatstraw says:

    “— assuming nothing else goes wrong . . .”

    The entire global economy was eaten through with cancer caused by massive fraud and criminality. The cancer was “cured” with a combination of mega-doses of carcinogenic quack medicine, bailing wire, A&D ointment, and tap-dancing.

    What could possibly go wrong?

  2. NoKidding says:

    “The relationship between income and purchase prices has been very stable.”

    Thats not what I see when I look at that chart. I see periods of stability during a clear upward trend in price/income. Putting a chart with median interest rate on a 30-year 20-percent down mortgage right below that one would explain the trend.

    The basic relationship is not income-vs-price. It is payment-vs-price.

    Link below has some charts I put togetherand posted in 2007 (before the crash). No advertising, just some good charts with terribly mistaken analysis. At the time I wanted to do something like Calculated Risk, but its way too much work to crank out content.

  3. bulfinch says:

    Maybe this is obvious, but I think what’s making rents go crazy right now is what amounts to a captive audience: bubble buyers with shot credit who either pay inflated rents or face potential dispossession. I’m not sure how much of a trend this will remain going forward. It may be that foreclosures become so widespread that to see one on an otherwise good credit score might become less of a factor.

    Also, regarding Texas: You’re right in that Texas didn’t experience a real estate bubble like Nevada or Florida or California; however, thanks to all the aggressive action these last few years designed to stabilize (reflate?) the hardest hit cities, home prices in certain parts of Texas have gotten pretty crazy. The effect of all these price props was like administering a shot of adrenaline straight to the heart of an otherwise healthy patient.

  4. tagyoureit says:

    Keep rates low has a cost. As Dolly Parton once said, “It costs a lot of money to look this cheap!”

  5. techy says:

    What if rates start to creep up to reach its normal avg of 5% ? IMO that is the biggest challenge right now.

  6. Ted Kavadas says:

    RE: “To date, we have not fully mean reverted…”

    Yes, I would agree that as far as price is concerned, relative to historical prices, we have not come close to a post-bubble “mean reversion.” I have illustrated this in one of my posts of 2010, seen here:

    As you illustrate in the post, there are many measures that one could use to value whether housing prices at this juncture are at or near a bottom. Currently, the average expectation among forecasters (as seen in the March Zillow Home Price Expectations Survey) is that prices will dip less than 1 percent in 2012, and then slowly climb through 2016.

    I continue to believe that a variety of factors will weigh against housing market prices. As to “what can go wrong” – IMHO there are many factors that could serve to further adversely impact values.

    Perhaps one of the biggest factors is rising interest rates. As you point out in the post, “…we must consider that the ZIRP policy of the Fed is keeping mortgage rates at unprecedentedly low levels.” The drop in prices has happened despite massive intervention measures, including mortgage rates that have been very low – often at record low levels – over the last few years.

  7. ironman says:

    Home prices having another 5-10% to fall is a bit low in our view, but is in the right ballpark….

  8. BenE says:

    I can give a reason why house prices should undershoot. Household income doesn’t tell the whole story. We also need to take into account the proportion of that income that needs to be saved for retirement.

    With lower expected long term investment returns and interest rates, the expected cost of securing retirement annuity goes up steeply and there is much less money left for everything else.

    All the the news article I read on the subject of house prices assume that low interest rates prop up prices since they allow for cheaper financing and lower mortgage payments. However, as a 30yo who would like to one day be a homeowner, this is not the effect low interest rates have on my budget. Here is an interesting fact: My house whenever I can afford it, will _not_ be the most expensive thing I will have to buy in my life. My retirement annuity is.

    Low interest rates correlated with low expected returns on investments make it much more difficult to save for retirement.

    I decided to try to quantify the effects of low returns on my budget:

    I calculated that if we managed to get 4% _real_ returns on our savings, which is what most online savings calculators assume by default and about what the previous generation got, we would need to save 23% of our income to maintain standards of living after retirement (This includes home equity and what the government saves on our behalf).

    If real returns were 3%, we would need to save 27% of our income, if they were 2%, we would need to save 35% and 1% would require saving 42%. This assumes a saving period from the age of 30 to 60 and retirement from 60 to 90. This is somewhat optimistic but with two equal periods of 30 years, it makes one data-point easy to calculate: With 0% real returns, we would spend half the money before retirement and half after so we’d have to save 50% of our income.

    Long term real returns going down from 4% to 2%, increases the amount we need to save by 12% of our income. This means we have this much less money to put on housing and other things. For example, if our after tax household income was $50 000. We would need to save an additional $500 a month ($6000 a year).

    Is it even possible nowadays to get a safe 2% real (~4% nominal) return ? The investment opportunities I see are closer to 0.5% or 1%.

    Meanwhile the cost of financing a $200 000 mortgage go down by $4000 a year or $333 per month when mortgage rates go down by 2%.

    If I bought the same house when returns and mortgage rates both went lower by 2%, I would need to find an additional $166 per month ($2000/year) to keep my retirement savings on schedule. If I decided to recoup this $166 per month by buying a less expensive house, at 4% interest, it would have to be $50 000 cheaper.

    I realize that expected returns and mortgage rates don’t necessarily move in sync and it may be that mortgage rates have bigger downward moves than expected returns but this still all makes me uncertain about my ability to spend on houses while saving for retirement.

    Also consider that new house buyers such as myself do more to influence prices than buyers that sell a house at the same time they buy. For those that already own, it’s a zero sum game where they can afford the new house as long as they can get the same value from their old one. Only new buyers can gobble up excess inventory. These new buyers are mostly younger people like me, and we are facing strong headwinds when it comes to employment and saving for retirement.

    Here is the math I did for reference:

    I : Annual Income
    S: savings ratio

    The amount saved each year of my working life is I x S
    The amount spent each year of my working life is I x (1-S)

    For example, if our household after tax income I=50k and we save 10k for retirement, S=0.20, we get to spend 40k that year.

    We would like to maintain our standards of living after retirement which means we would like the amount we spend I x (1-S) to be equal the amount of our retirement pension payments. That is, if we save 20%, (spend 40k, save 10k) we would like to get a 40k pension at retirement.

    The value of our savings at retirement should be enough to give us this annuity. To calculate S, the proportion of our income we should save to achieve this goal, I take:

    Future Value of my savings FV(I x S) = Present Value (at retirement) of the pension annuity PV(I x (1-S))

    Taking the formulas from here:

    I arrive at

    S = 1/( x + 1 ) where
    x=1/((1-1/(1+i)^m)/((1+i)^n – 1))

    (See )

    i is the real (above inflation) returns on my investments which, assuming I don’t take too much risk, should follow the trend of long term real interest rates.
    n is number of years we are savings
    m is number of years we plan to be retired.

    Lets say, that I start saving for retirement at 30, retire at 60 and live to 80. That’s 30 years of savings and 30 years of being retired, a somewhat optimistic scenario (n = m = 30).

    Here is the graph showing how much we should save relative to long term real returns on investments ( ).

  9. Great article – very interesting analysis.

    I’m currently discussing with my finacee as to whether we should buy a house or not. This series, and especially this post, will help me guide her away from blindly listening to the headlines and family members that say, “homes are at historically low prices,” and towards making a rational and thoughtful decision.

  10. Robespierre says:


    I notice that all the graphs you post on housing/pricing/affordability are bracketed by the baby boomers generation. Wouldn’t demographics have a huge impact in housing because of the aging population (like Japan?). I’m thinking that cashing out and renting in retirement communities make more economic sense for these huge segment of the population. Also won’t the houses being put back into rental lower the rental cost (more supply) and therefore make housing more expensive?


    BR: Enormous — the boomers drove the boom, they will also drive more supply as they retire

  11. Mark Down says:

    That’s why they pay BR the big ……” we need to see homes cheap enough that they fall in the right hands”
    Johnny lost his job. Mary got Breast Cancer ….guess there not the ‘right hands’ people anymore!

  12. Mark Down says:

    That’s why they pay BR the big ……” we need to see homes cheap enough that they fall in the right hands”
    Johnny lost his job. Mary got Breast Cancer ….guess there not the ‘right hands’ people anymore!

  13. Clem Stone says:

    I don’t recall the S&P careening wildly past (under) fair value after the bubble in 2000.


    BR: Two factors: 1) we have yet to see the end of the secular bear market (circa 2014-18) that is the 1946 or 1982; see this chart: P/E Expansion & Contraction

    2) Both Greenspan & Bernanke have artificially propped up equity prices

  14. [...] –”The Problem With Home Prices“; The Big Picture (April 4, 2012) [...]

  15. ironman says:

    Clem – you likely missed a pretty good chunk of time in 2002 and 2003.

  16. gordo365 says:

    But – the equivalent rent portion of CPI remains flat as a pancake…

  17. wally says:

    “Let’s begin with current prices: The most recent Case Shiller index of national prices (January 2012) reveals that prices are still falling, about 4% year over year. ”

    And yet, when we look city by city, that’s not what we see:

    The majority have started back up or stabilized. Again, that’s the deception of looking at “housing” as a single number.


    BR: No, thats wrong. 3 of the 20 areas were up, one was flat, the remaining 16 saw year over year drops in price.

    See this

  18. obsvr-1 says:

    We have avg / median house price; we have avg / median incomes; we have avg / median net worth

    but in looking at housing investments, rent vs buy decisions has anyone ever seen avg / median maintenance on a house. These things called houses are decaying (depreciating in real value) over time. Just when you have saved a bit for a new toy or vacation, it seems the house comes a calling with a hot water heater, the furnace, the air conditioner, the roof, the exterior siding, the paint job, a leak in the plumbing, not to mention the weekly lawn care, seasonal landscaping. Don’t forget the furniture, drapes, carpet/flooring …. etc, etc. Damn these house things are really expensive.

    Oh yeah, you have to give it to the realtors and those DYI shows when they suggest remodeling work; wow you can get 60 -90 cents on the dollar for remodeling your bathroom, kitchen etc … Can you just imagine your financial manager boasting you can get $.75 for every $1 invested — such a marketing job and Home Depot / Lowes demand generator.

    And just when you “invest” 50K in improvements into your 400K house, the market falls 35% eating not only your 20% down payment (as a prudent buyer), but also all the money put into improvements. Now with the home underwater, wages flat, potentially lost income (job loss or change to lower wage); what was once in the hands of a prudent buyer now belongs in the hands of a vulture investor ? Maybe true, but it still sucks.

  19. Lord says:

    We will see nominal prices flatten over the next year but slide in real terms for many more. We won’t see real prices rise until late this decade. It will be a reasonable time to buy to live in, but not not to expect gains for some time.

  20. sbcharo says:


    Great post…the “macro” view is certainly accurate…

    Although we’re in the midst of multiple offers in our local San Diego housing market, I concur that we still have some price depreciation in front of us.

    @DollarsAndCocktails…the decision to buy a home right now or later has to do with many factors, not just market timing the bottom of the bubble (your job stability, amount you pay in rent, the price range you would be buying in, interest rates, and how much distressed inventory is there in your areas of interest, etc). If it costs you more to rent than to buy, and you are in a housing market that was one of the first to start contracting, like Boston or San Diego, it might make sense to think about purchasing. Then within those metro markets, certain zip codes did not have the speculation that others did…so it depends on where in your area you are considering buying…All of these factors are “knowable” by the way…

    My point is that there are individual and geographical factors at play…not to mention personal :) buying a home with someone is more complicated than marriage :)…i’d wait for that reason alone!

  21. SANETT says:

    Absent living on the street, you are buying a home. The variable is whether you’re buying it for someone else by paying rent. Given the collapse, low interest rates and the fact that catching bottoms is as hard — maybe random — as catching tops, why aren’t people who plan on staying alive for a while buying homes? And they’re paying $600 or so for Apple stock? Guess if you follow the herd you end up where the herd goes, not often all that great.

  22. KS says:

    Looks good. There are two things I would mention

    1) As an economists focused on macro-issues I think more about quantity than price. From my perspective – as you may have heard by now – I think there are two few homes in America. Right now I agree that getting a mortgage is going to be difficult but this means that the demand for rentals should be skyrocketing and so far the incoming data have supported that thesis.

    So, from the perspective of some one asking – Is Residential Investment as Percent of GDP going to rise, my answer is a strong Yes. Even if Single Family starts do not move. Though at this point I would be very suprised if we saw SF starts *fall* below 400K SAAR.

    2) From a monetary economics perspective I see the chance of a new bubble arising as very likely. Indeed, I would rate it almost a certainty that in the next few years some bubble, somewhere will arise again.

    It may seem insane to suggest this, but its not completely off the wall that it could be in housing again. Why?

    Well my analytically framework suggests that the world is desperately short of safe assets. Monetary economists think of safe assets as being a form of international money. You need asset that you that you can hold as a liquidity hedge.

    Obviously US Treasuries are the safe asset of choice but there are not enough of them to support global finance. This why the long term yield on US Treasuries has been persistently lower than fair-value analysis would suggest. Treasuries are in a long bubble.

    Now, from our perspective not all bubbles need to pop. For example, cash – as in the stuff in your wallet – is a bubble. Its fundamental value is basically zero. Yet, people will trade you all sorts of valuable stuff for the cash in your wallet. This is because they expect other people to also except cash.

    You could say that they are all “Greater Fools” but as monetary economists we would say that Cash earns a liquidity premium. The fact that you can use it to trade “makes* it valuable. Thus so long as cash remain liquid the cash bubble will never pop. Indeed, it is the job of the Federal Reserve to make sure the cash bubble never pops, that is that US currency retains its value as a medium of exchange.

    In any case this shortage of safe assets means that if any set of non-traditional mortgage instruments starts to appear safe again it could well be that they blow-up into a second bubble.

  23. tradeking13 says:

    It would be interesting to see what the mean on these charts was prior to the great housing bubble.

  24. [...] Part 3 of 5 of Barry’s look at housing affordability. Since real incomes are stagnant, higher rents are no more sustainable than higher house prices to me so the rent vs buy comparisons present an overly rosy view for that reason too. The upcoming mortgage rate installment should be interesting since the chart from Ned Davis Research shows median prices of ~3.7x income as the cutoff for cheap houses. 3.7x with 20% down means lenders are doing loans for 3x income. When I first bought a house, in a period with significantly higher rates, 2x income was hard to pry loose. The further back you go the lower that ratio gets. In the early 20th century 1x income was a hard sell. [...]

  25. The New American Dream: Renting

    Surveys show that Americans buy into our gauzy platitudes about the character-building qualities of home ownership—at least those who still own them. A February Pew survey reported that nine out of 10 homeowners viewed their homes as a “comfort” in their lives. But for millions of Americans at risk of foreclosure, the home has become something else altogether: the source of panic and despair. Those emotions were on full display last week, when an estimated 53,000 people packed the Save the Dream fair at Atlanta’s World Congress Center. Its planners, with the support of the Department of Housing and Urban Development, brought together struggling homeowners, housing counselors, and lenders, including industry giants Bank of America and Citigroup, to renegotiate at-risk mortgages. Georgia’s housing market has been devastated by the current economic crisis—6,605 homes in the Peachtree state went into foreclosure in May and June alone.

    Atlanta represents the current housing crisis in microcosm. Since the second quarter of 2006, housing values across the United States have fallen by one third. Over a million homes were lost to foreclosure nationwide in 2008, as homeowners struggled to meet payments. The number of foreclosures reached an all-time record last month—when owners of one in every 355 houses in the country received default or auction notices or were seized by creditors. The collapse in confidence in securitized, high-risk mortgages has also devastated some of the nation’s largest banks and lenders. The home financing giant Fannie Mae alone held an estimated $230 billion in toxic assets. Even if there are signs of hope on the horizon (home prices ticked upward by 0.5% in May and new housing starts rose in June), analysts like Yale’s Robert Shiller expect that housing prices will remain level for the next five years. Many economists, like the Wharton School’s Joseph Gyourko, are beginning to make the case that public policies should encourage renting, or at least put it on a level playing field with home ownership. A June 2009 survey commissioned by the National Foundation for Credit Counseling, found a deep-seated pessimism about home ownership, suggesting that even if renting doesn’t yet have cachet, it’s the only choice left for those who have been burned by the housing market. One third of respondents don’t believe that they will ever be able to own a home. And 42% of those who once purchased a home, but don’t own one now, believe that they’ll never own one again.

  26. Chief Tomahawk says:

    No one mentions those taking foreclosure will take credit hits and likely be out of the housing market for 7 years (unless they win the Powerball).

  27. [...] All this week, we are looking at the Housing Recovery theme, challenging assumptions that make up the bullish argument. Monday, we began with Debunking the Housing Recovery Story, starting with Shadow inventory. On Tuesday, it was Reality Check on Home Affordability. Yesterday, we looked at the Problem With Home Prices. [...]

  28. obsvr-1 says:

    Chief Tomahawk Says:
    April 4th, 2012 at 10:47 pm
    No one mentions those taking foreclosure will take credit hits and likely be out of the housing market for 7 years (unless they win the Powerball).


    Watch how fast the banks will lend again to some (if not a majority) of these folks once the economy is back humming and they have income to seize (replace seize with use). Bankers have ingrained greed and short term memory.

  29. [...] In fact, my dialogue with Barry was echoed in the “Comments” section of his blog, “The Big Picture.” [...]