I was reading the Wikipedia entry for US Housing Bubble, and came across this troubling graph from the book Irrational Exuberance. I’m trying to find some rebuttal articles to this graph.
Interesting Housing Bubble Graph
Posted on December 6, 2006 // 36 Comments
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That’s going to be hard to rebut. It’s pretty well established that home prices are out of whack with incomes. Think of home prices to income as the equivalent of the P/E ratio in stocks.
Even if home prices were to remain flat for the foreseeable future, it would take over 10 years for incomes to justify such home prices based on historical metrics.
Looks bubblicious to me. I think the media is a good reflection of bubble activity. It seems every channel now-days has a show on about increasing home value through renovations, buying and flipping real estate, the high value of homes across the country, etc. I think the real estate craze has permeated our society, who knows how it will turn out.
Playing devil’s advocate: I have seen this chart while doing similar research, and was quite bothered by it. Maybe we should look at what exactly the “Home-Price Index” is. Is this a commonly excepted metric for determining housing value?
I don’t know, it still might not be a bubble. I agree that it is getting very difficult to afford a home on most salaries, but if the population and cost of building keep going up, that could very well explain the increasing cost of housing.
Well the “Bubble” is over here in Detroit. Tons of forclosures. Housing prices slashed. People still can’t sell them.
My neighbor can’t sell his $450K home for $319K.
Bad time to sell, good time to buy…….
Shiller is a permabear, so of course he will be negative on housing. Also the thing is inflation is a lot higher than what is reported(look at your medical, utility, and education bills all rising double digits), so housing is moving along with inflation. I do agree there is a little too much speculation so there will most likely be a minor correction but nothing big. And seriously EVERYONE is bearish on housing, its like GOOG stock, EVERYONE was bearish on it and now its up 500%.
it’s on your blog roll, but here’s a good site (from a canadian perspective) about this topic:
search for “housing bubble” yields:
of which, he discusses the bubble’s (graphed):
link
I find it to be interesting stuff. . . especially to see that the trend is not exclusive to the U.S. (or North America even, given the UK’s chart). . .
Here’s another version of the graph, with some annotations.
link
That graph is deceptive. Use photoshop or something to transform the origin of the four graphs to the same point, and provide scales on the bottom two quantities which can be understood. Whoever wrote that graph was either naive, or, trying to trick people.
The ratio 185/161 (the ending values of the top two graphs) is not reflected in their relative height. Instead, thanks to the Y-translation AND the different scale of the origin of the higher graph, it appears over twice as high, instead of 12% higher.
I can’t rebut the data, there clearly is a bubble. But come on, lying to defend it?
If home prices are so unaffordable how come over 60% of the population owns a home? Wait – the banks own the homes.
The only thing troubling about this graph is how meaningless it is.
Real Estate is LOCAL, national trends are fun to talk about but to a large degree people should be worried about their house more than houses that were built and sold in the middle of the desert…
If you are in an area where land is limited and it’s very desirable to live (good weather, jobs, hospitals, schools), those things aren’t likely to change. However, if you are in an area that has issues (like lack of water, jobs leaving, etc), or there is plenty more land to build on, there’s a good chance you may have paid too much. There were definitely bubbles in certain areas of the country.
A few other things that should be added to that graph is the income of home buyers and the Interest rate on loans. In the 70s loan rates were over 10%!
Another statistic that is useful is the ratio of mortgage payments to rental payments.
Another thing that these graphs don’t caputre are the tax incentives of real estate. The Government is practially begging people to buy and sell houses by giving them writeoffs for interest and then making it possible to make 250,000 – 500,000 tax free every 2 years…
@Robert: Relaxed lending rules. i.e. Financing 105% of the home value is unheard of before the last few years. Also the new 50 yr mortgages. Bank #1 financing 80% (normal) and bank #2 financing the other 20% the same day.
Gavin Peters said:
“The ratio 185/161 (the ending values of the top two graphs) is not reflected in their relative height. Instead, thanks to the Y-translation AND the different scale of the origin of the higher graph, it appears over twice as high, instead of 12% higher.”
I don’t think that’s the point (although I agree the presentation is misleading). If you look at the Home Price Index, it has never gone above about 120. Furthermore, the only big spike before the current one was based on the post-war launch of the suburbs. There is no corresponding fundamental support for for the recent larger spike.
Jonathan,
I am a semi-long term lurker of your site and I must say that I truly admire your dedication to being a wise consumer and investor. A lot of your posts talk about things that I am always thinking about or noticing going on in the world.
If you think you are overly cheap/anal when it comes to spending and saving money, I am right there with you, if not worse (not that these are bad traits).
Anyways, to the interesting stuff…The first thing that caught me about this post is that I have this exact graph up as my desktop background at work. I have closely followed the real estate trends in San Diego (where I live), Los Angeles (grew up), and nationwide over the past several years. I spend several hours per day doing research on past, current, and future trends for housing as well as the economy in general. I am absolutly fascinated with what has happened in real estate and it is a major hobby (I do not work in a real estate related field).
All of this being said, I would like to make several oppinions which I have formed after looking at lots and lots of data.
1. Real estate is generally local, but during the past 6 years or so, we have seen a much larger than normal correlation between different areas across the country…i.e. we are not dealing with a local phenomenon here.
2. Real estate is very cyclical (albeit with a strong, long term uptrend). We have seen prices rise modestly from the recovery starting in the mid 90s and then rapidly pick up around 2001 or so (give or take a few years). We also know from the last cycle that the past downturn started in the late 80s and didnt fully bottom until the mid 90s. This being said, I would argue that since we have hit the peak in the last 18 months, we have a LONG way to come down and correct. I don’t really want to mention it because it is an extreme example but prices declined for almost 20 years in Japan before appreciation kicked in again…real estate is a very slow moving ship!
3. I feel that we can safely say we have hit peak already and are on the way down due to the recent statistics that have come out which were unprecidented…we have seen year-over-year price declines on a national level for several months straight…this has never occured, AND these are nominal decreases which means that accounting for inflation, the decreases are much worse. Additionally, builder incentives and cash back at closing schemes distort the data in a positive way, which means things are worse than they appear on the surface.
4. The last thing I will touch on relates to my first point about real estate not being local anymore. We have not really seen a real estate bubble here…what we have seen is a massive credit/liquidity bubble that manifested itself in the form of real estate. Financing was given to anyone regardless of income (think stated income aka “liar” loans), credit score (think explosion of sub-prime market), etc. People bought property on sheer speculation of gains and under normal circumstances could not afford the payments. So yes, we had/have a massive real estate bubble but it was/is all fueled by credit and the enormous amount of liquidity in the system.
So after my “bearish” points (i prefer to be agnostic and data driven), I would argue that you should continue to rent for at least several more years to come…this is another point that I should have made…rents in many areas are half or less of what a mortgage payment would be on an equivalent property using a 30 year fixed (even with 10 or 20%) down. Owning will always command a premium, but until rents come closer to being in line with the cost of owning and we see less speculation in the market, I would argue you should absolutley not buy.
BUT, if you are in an area where you can afford to put 20% down and get a 30 year fixed mortgage on a property that you love and the monthly payment is approximately 1/3 of your income, then you can afford it…you may lose money if you have to sell in the next 5 or even 10 years, but at least you will be able to make the payments and continue saving money for retirement.
I can see that you are really going to put in a lot of time and research into this and I hope that I have helped you form more of an opinion or at least stirred up your desire to know more. I truely believe that we are in the very early stages of this and that waiting will be rewarded. Good luck with everything and keep us up to date with what conclusions you come to.
P.S. There are a lot of websites that are very biased and overly bullish or bearish on this subject. THere are also a lot of really good ones. I didn’t really want to put any links up, but there is a great presentation on the historical values of real estate combined with a ton of useful data at piggington.com
Let me know if you (or anyone else here) has further specific questions or things that I can help out with…I have no selling agenda or anything, I simply enjoy this blog and the people here and I want to contribute my knowledge. I hope this helped.
Craig,
Good post. I agree with most of what you said, but especially point #2. Sometimes I don’t think people appreciate how extraordinary the run up in prices has been over the last several years. To think that we’ve hit the bottom just because we’ve had a bad few months is absurd. The fall has just begun.
Many of you have read Bernstein’s asset allocation book. Here’s his quick take on the real estate bubble:
http://www.efficientfrontier.com/ef/405/housing.htm
The graph is largely self-explanatory as the single most significant source and driver of rising home price is demand created by a rapidly rising population struggling for the American dream. And, since the U.S. is one opf the few places in the world where “average people” can acquire their own home and create and usually retain a stable and valuable estate, demand by foreigners is also increasing but
largely uncharted. Clearly, an 85% increase in a home-price index is not only easy to understand in a population
that has simultaneously increased by more than 400% –
it is also sustainable.
If you want to use a P/E-like measure, calculate the cost to own of a house or condo (interest plus property taxes plus HOA fees plus maintenance minus income tax writeoff) to the rental cost of an equivalent property. In a lot of areas, it’s far cheaper to rent than to own, which is not a good sign at all.
The only rational reason why owning a house would be significantly more expensive than renting is if you expect a lot of real appreciation when you sell the house. This is the classic bubble mentality: housing can only go up! No, it can and has gone down.
At one point I saw similar graphs only they were broken down by metro area. To all those that say that there is something misleading about the graph, how do you explain the fact that graphs for southern and midwestern cities are much more linear and lack the giant spike at 2000+? Has something changed in only the past 6 years that suddenly made living on the coast(and Phoenix, Las Vegas, Chicago) much more desirable? Certainly we had the tech boom in the late 90’s that would have affected the Bay Area and the Route 128/495 corridor. Maybe a first time boom for the Bay, but 128/495 has certainly seen it before, so nothing new there. Can the baby boomer retirements explain Florida? Why isn’t there a corresponding drop elsewhere then? It certainly is not all Detroit people moving to Florida.
I should say that I believe in Schiller, but here’s some rebuttals because you asked. One (from Toll brothers) is that people in Britain pay a lot more as a percentage of their income in housing. So there’s nothing intrinsic to paying whatever people pay in the US for housing. (Rebuttal to that: what do we pay as a percentage of income AFTER health care expenses?) Another more Greenspanian “soft landing” argument is that with new methods of providing mortgage credit to people, (ARM’s, repackaging mortgages into credit backed securities with appropriate risk/yield) we can effectively get more people in the game, which will reduce the supply/increase the demand of houses. So the bump up that we see between 1980 and 1995 will be as sustained as the one after WW2. An argument against this is floating around blogs like BigPicture(that the increase in lending is due to an increase in the money supply, and is unsustainable), or The Mess that Greenspan Made (that the increase in lending is not appropriately hedged for risk and will pop.) Oh, and Shiller is not a permabear, or else he would predict no bubbles ever.
Sorry I’ve been really geeking out on housing, which I’m sure is bad for my health, but I lived through the .com bubble in San Francisco and I think I’ve got bubbles on the brain. But the Schiller book is a great read. Let me know what you think of his S&P500 bubble graph later in the book!
I’ll take the other side on this one.
I highly doubt the Helicopter Ben Bernanke and Mr. Paulson will let housing drop too much. They know what the risk to the economy will be if we get mass deflation in housing. Once they get a wif of decline in housing, they will flood the economy with cheap money, inflation will skyrocket and the price of houses will stop dropping (but in reality it is droping against true buying power).
On a more practical note: if you are considering buying, take a comprehensive look at your needs and cost, consider all factors such as opportunity cost of your down payment, cost of rent, tax deductions, living conditions, schools for kids, “wife nagging you all the time about buying” and etc. Buying a house is not all about dollar bills YO..
If you are unsure about inflation and a housing bubble, please read this:
The government has a deep interest in pretending inflation does not exist. Entitlements, which comprise around 54% of the govt’s annual budget, include such items as social security and disability payments. If inflation is going up, they have to increase payments to match inflation.
The Federal Reserve also wants to pretend inflation is low (re: “core” inflation
I would be interested to see how mean household wages stack up to housing prices. If people aim to spend 30-40% of their wages on housing, the truest test of a buble should be comparing these two measures.
Real Estate market is local but one big driver of it is national ( even global ). That driver is the interest rates and lending policies.
Wes – I did read Bernstein’s article back then, it’s very interesting. I would add that I think relaxed lending policies (due to the repackaging of mortgages and thus less risk to the bank) has also increased housing prices. People can borrow more with the same income now than before, even ignoring low interest rates. Whoever heard of an 80/20 loan 25 years ago?
Yep, real estate is definitely local, but I think the overall trends are still nationwide. I was small-talking with a Realtor acquaintance and she says buyers are definitely getting more scarce.
All I want for Christmas is for the housing market on the West Coast to hit bottom in Q3 2007! 😀
Craig,
I appreciate all of the research that you have done. Would you mind sharing some of the links that you use to research the real estate market?
Thanks,
David C.
Bottom in Q3 2007? Should i short sell the Real Estate ETF’s in favor of your purchase Jonathan, and margin leverage it with 0% balance transfer monies instead of my silly broker who charges ~11-12%? Just kidding. To be honest, thanks for the post. It would be interesting to see how rental rates for 1br, 2br would fall or correlate with the housing index. From 2002-2005, rentals in my area have been near bottom and flat…while housing prices have skyrocketed. Now, rental rates have increased ~5-12% for 2006, and housing prices have finally came down abit; though, still, abit high in myopinion. (condos– a 600sqft 1br costs around $170k where i live; and probably similar to where you live tooo.) It is local. But, in general, take boston, los angeles, sandiego, phoenix, and DC areas; they all have seen prices for condos/houses drop from anywhere between 2-10% off. Flipside, mortgage rates have increased since their lows in 2005(?).
David,
Here are some of the best data driven intelligent links that I am aware of that discuss housing:
http://www.piggington.com/
http://calculatedrisk.blogspot.com/
http://interestrateroundup.blogspot.com/
http://bubbletracking.blogspot.com/
I have no affiliation with any of these blogs, but I read them often and am very impressed with their presentation of data that you will not hear the “main stream media” talk about. Enjoy
Craig,
Just digested your first comment. I really agree with you on the credit. I think there is a great link between what the banks let buy, and what people are buying. I wonder if that will change in the future, though. Will these loans go away?
Re: Loans going away
If banks start losing money on Pay Option Arms that get foreclosed and have to be sold for less than the balance of the loan, then yes I think those loans will go away (or the rates will go up to unattractive levels). Mortgage brokers sold a lot of bad product to people who were anxious to get in on the real estate boom.
If a large amount of loans adjust (ARMs, IN-Only ARMS, Option Arms, Neg Am Limits are hit) and people have to panic sell or the house goes into foreclosure we will see more downturn.
That being said, in attractive areas there will be plenty of buyers to keep things going. But in oversold “hyped-up” areas there will be pain.
So, where are all the people that said there was no bubble?
Everybody that has purchased a “bargain” last year, is in deep trouble.
We’re heading back to the prices of the ’90s. And that is the best news.
How do you feel the market has changed since this post?
would like to see update to this information
It would be interesting if we could update this graph for 2013.