Working on the figures

Far more experienced people than I admit to uncertainty when it comes to the state of real estate.

Are we headed for a double dip as some analysts predict? Or is the worse over as others proclaim? (For example: Karl Case recently wrote, “Buying a house now can make a lot of sense.”)

The key word, here, is uncertainty, rather than confusion. Boiled down, the basic question is -Does a house represent a luxury, or is it a roof over your head – a staple like food and clothing?

This was addressed in “The Bears and the State of Housing,” by David Leonhardt in the NYT on Sept. 7.

I’ve simply boiled down what he said, for myself, so that I can better understand what’s going on. And, so, he’s the brains, not I, and here’s what he comes up with, if you care to follow along.

Those who say that housing is like a luxury good, claim that when people get richer, they spend more on housing, so the cost of housing rises with increased income.

Those who say it is more like a staple, they believe that home prices rise with the price of inflation, more in line with food.

From 1970 to 2000, home prices did rise with incomes, and that seems to be something that everyone agrees upon. But, the bears say, that was an exception. The government added tax breaks for home ownership and interest rates were falling and those days are over, they say – and they point to data compiled by Robert Shiller that shows that house prices rose no faster than inflation during that period. As people get richer, they spend less of their income on staples, obviously (As you get richer, you don’t usually spend your extra income on groceries). So, houses prices should rise at about the same rate as general inflation, and well below income.

If that is true, house prices may still be overvalued by about 30 percent (the gap between the average household income growth and inflation over the last generation).

Shiller’s index suggests the same overvaluation. Today, it is around 130, which is down from the 2006 bubble peak of 203 but far above the 1890 to 1970 average of 94.

The other side (including economists like Case, Mark Zandi (Moody’s Analytics) and Tom Lawler (a Virginia economist who was one of the first to predict the end of the housing boom), they believe that house prices rise almost as fast as incomes.

Case bases his case on the fact that statistical housing information pre-1970 is patchwork. Shiller’s index, for example, relies on several sources, like Labor Department surveys, which often paint a more negative picture of past house prices than other surveys. The Census Bureau, for example, since 1940, has been asking people how much they think their house is worth (Lawler writes about this in one of his newsletters), and the answers suggest that home values rose as fast as incomes.

Then, there are Shiller’s statistics that show that consumer spending (i.e. income) devoted to housing has hovered around 14 to 15 percent for the last 60 years, while food, by contrast, has dropped to 13 percent from 25 percent.

Then there’s the old location, location, location. Zandi says, overtime, the value of the land should grow almost as fast as the local area’s economic output (or income).

In the end, based on all this, here’s Leonhardt’s best advice — he put’s himself in the less bearish camp — don’t think of a house as an investment. Think of it as a place to live. If you are going to move within three years, rent, because the hassle of buying and the one-time costs are too big.

And, he adds, since the economy is weak and there are still a high number of foreclosures, prices may continue to fall during the next year or two, and, if income growth remains weak for years, it might hold down the home-price growth.

On the other hand, if you do plan to stay longer than three years, eventually, he believes, prices should begin to rise again, maybe not quite keeping up with income, but outpacing food and clothing.

Sounds like a long way of getting to the end, but it’s an interesting train of thought, don’t you think?
In my research, people that I talk to have come to the same conclusion, but it’s nice to see the underlying reasoning plotted out.

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