Tuesday, April 04, 2006

Good data on housing

I've been slow to recommend this excellent post detailing a recent paper by Robert Shiller who argues that housing is unsustainably high. Shiller has been thinking a lot about bubbles, and the types of systematic risks they pose, since the hedge fund explosion in 1998. He has created an index that has tracked the price of the same house, inflation adjusted, over the past 100 years, and has found it to be extremely flat, with a dip during the Great Depression, and a huge hockey stick right now.
Do real home prices have a substantial long-term uptrend? The chart suggests not. First, what about the United States? ItÂ?s notable that until the recent explosion in home prices, real home prices in the United States were virtually unchanged from 1890 to the late 1990s. The Amsterdam data show lots of ups and downs, but only the slightest hint of an uptrend. Prices approximately doubled, but it took nearly 350 years to do so, implying an annual average price increase of only 0.2% a year. The Norway data do suggest such an uptrend, but viewed from the longer perspective of the Amsterdam data, that uptrend seems to be merely part of a long cycle from the early 19th century to the late 19th century. And even leaving the context added by Amsterdam aside, NorwayÂ?s real price growth is, on average, negligible: only 1.3% a year.
Moreover, he argues that real rents have been declining, which suggests that the price/rent ratio has been growing, with prices flat and rents declining.
In theory, one might expect real home prices to represent the present discounted value of future rents. After all, people can move from renting to owning with relative ease. And while thereÂ?s an obvious tax advantage to owning..., that advantage could be easily valued and taken into account in the calculations. If [so]..., then prices should closely track rents. ... In practice, however, the situation is very different: Not only do real home and rent prices fail to track each other, but the rent-price ratio has shown a remarkable downtrend since 1913. (See Figure 4). But why?
This long term trend has grown dramatically in recent years as rents have fallen further, and prices have spiked.

By contrast, some other economists are arguing that house prices are currently quite reasonable if you calculate their value in strict cash flow/NPV terms. I file this firmly in the "publish something contrarian to get attention" category as their story lacks a reason for why prices have been ludicrously low for the past 95 years, and NPV calculations are notoriously sensitive to small changes in discount rates.

Arnold argues that one likely reason for the new prices to be reasonable is that
In my view, there are good reasons for a liquidity premium to have shrunk over time. The mortgage market has become more efficient, so that the cost of having money tied up in a house has fallen. This story suggests to me that the rise in prices from historical norms could be rational.
I am interpreting this as arguing that it is easier to refi, and so get money out of a house, which means that housing is more liquid that it used to be and no longer commands discount. If prices stay where they are I think that that needs to be the story.


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