Monthly Housing Price Indexes Only Tell Part of The Story for Real Estate Investors
Each month Case-Shiller, CoreLogic and others publish changes in housing prices for major cities across the United States. How useful are these statistical reports for real estate investors when it comes to when and where to invest?
Many investors use these housing price reports to plot real estate investing strategies. By and large users focus on year-over-year price changes to determine "where the market is headed". Viewed monthly, or even on a quarterly basis, do these reports give a truly useful picture of what's going on?
By all appearances the now-famous "housing recession" is well along its way to recovery. Investors are heartened by the continuing up-ticks in housing price indicators reported on a monthly basis. The media focuses on these housing statistics as economic indicators:
"Housing prices have jumped 25 percent from their trough in 2011, which followed their worst slump since the Great Depression. They now sit just 7.6 percent below their 2007 peak, according to S&P/Case-Shiller index data." (This according to Bloomberg Business columnist Jody Shenn in his report on a Bank of America forecast of a leveling off in such increases beginning 2017.)
The B of A gloomy forecast is largely based on economy-wide slow jobs and real income growth: Absent growth in household incomes, housing affordability becomes an issue. A recent National Public Radio segment raised similar concerns (listen here).
Redefining the Housing Recovery
For many property owners the recession in housing will not be over until their home recovers its pre-recession market value. This measure seems to guide media commentary as well. A glance at the graph above shows that, nationally, home prices may not have far to rise to equal the (Bubble-driven) prices of 2006-2007. If you were among those who purchased their home at the peak of the market, this is good news indeed.
But this apparent success in recovered "value" is based on data collected nationwide and averaged. Individual cities, states and even regions have not shared equally in this recovery. While some markets are celebrating good fortune, others wonder when they too will get to mount the band wagon.
Even within certain cities–Chicago is a case in point–so-called "prime" neighborhoods were among the last to lose value and first to recover. Meanwhile other neighborhoods lag behind or languish, still struggling with reduced property values and distressed, unsold foreclosures. What will define "recovery" for these neighborhoods?
The Measure of A Successful Recovery
It may be all about expectations. Beleaguered homeowners, struggling with high mortgage balances and perhaps "negative equity" (a mortgage balance greater than today's market value) won't be satisfied until the market value of their homes equals what they paid in the mid-aughts if they were buyers, or the "appreciation" they thought they had earned as the Bubble drove prices ever upward. Sadly, this begs the question of just what constitutes a real estate "bubble".
A bubble occurs when factors likely unrelated to any real measure of value converge to drive up demand and, consequently, increase prices. In the early 17th Century the Dutch became obsessed with tulips (!) and, over the course of nearly three decades, there was a lively–some would say frenetic–and quickly rising market in tulip bulbs; today it's referred to as a "mania". Fortunes were spent on rare varieties.
And then the market collapsed, and fortunes were lost. The entire phenomenon was based on perceived value, not inherent value. And, when the "bloom was off the tulip" (as some might say) all you had was a pretty flower for your garden.
In our case, the market forces creating the housing bubble were a combination of relatively low interest rates, permissive fee-driven lending standards, and a newly created investor market both here and abroad for "bundled" mortgages (many of which, as it happened, of questionable value). As prices were bid up everyone, it seems, wanted a "piece of the action". With prices rising all around, how could one lose? Price had become unmoored from value.
We need a Housing Recovery based in Reality
There is little to be gained carrying forward unrealistic expectations originated in the heat of a housing bubble. If we accept the fact the bubble itself was an aberration, why assume the peak values realized at that time represent prices to be realized today as an indicator of a recovered real estate market? Or is there a better measure?
I am not an economist, "micro" or "macro". But I read a lot of history, which does contribute to a certain world view: The more we believe we are witnessing change, in fact the more all has stayed the same. As we went through the trough of the housing recession I took comfort in this notion. I never believed "the End was drawing nigh".
A Contrarian View
In fact I argued that, given time, we'd end up right where we should be. And that argument was based on "historical trends". The housing recovery, whenever it was to occur, would reflect the continuation of annual housing price increases at or just over the annual rate of inflation.
I must say I was not without doubters. Times were tough. Stock prices were falling, as were home values. We were witness to ever mounting numbers of foreclosures. It was not unusual to hear of those predicting the veritable collapse of the the housing market.
While not normally a contrarian, I urged those who would listen to buy! (as I continue to do today). I did not invent the adage "Buy low and sell high" but I certainly subscribe to the advice. There were houses on offer in our market for 15-20% of pre-recession market values! We didn't need calculators to measure potential ROI (return on equity). Nor would we need much of a recovery to enjoy substantial appreciation as values were restored.
While there was little prospect of a quick resale during the recession, the rental market was as strong as ever. The natural demand for rental housing was and is today, if anything, increased by the housing needs of those displaced by foreclosure–as owners or tenants of landlords losing their properties to foreclosure. As today's calls for more "affordable housing" attest, this demand for rental housing continues and is growing.
Why the Housing Recovery is already accomplished
The explanation for what should have been a predictable "correction" in the real estate market (the fall in prices), and confidence in today's recovery, rests with understanding the historical trends underlying real estate values and inflation over time.
Since the turn of the 20th Century, since about 1900, property values over time have tended to increase at an annual rate of 3.1%, or just over the rate of inflation. Again, referring to Case-Shiller data, this is illustrated in part in the graph above going back some sixty years, and more clearly in the graph below going back to 1900 for its benchmark:
From this graph we are able to see gradually increasing prices through the first 50 years or so (including the decade-long Great Depression) until the post-war housing boom beginning in the late 1940s. Beginning in the nineteen fifties, both inflation and home prices began to increase at progressively faster rates, culminating in the extraordinary runup of the Bubble in the decade following the turn of the Millennium. This represented an annual percentage increase, as mentioned above, of just over 3%.
It is interesting to note that not even during the depression of the 1930s did property values drop significantly. Rather they appear to have merely "flat-lined" during that economically stressed decade.
Conclusion–Economic upturns and down tend to "even out" over time
Stock market analysts use the term "market correction" when describing sudden declines in securities markets or specific market segments. Recall the "dot com" bust of the late 1990s. Over a period of five years investors bid up the prices of internet-based technology companies. Underlying financial strengths or, more often, weaknesses of such companies were overlooked or discounted in anticipation of extraordinary future profits.
So too with real estate. (When will we learn?) Home values became unhinged from home buyers' ability to pay. Faced with prospects of easy profits, investors and speculators joined in the fray. And, of course, much of this was supported with enthusiasm by lenders demonstrating little concern with the long-term quality of loans they were underwriting.
Today, showing little remorse for the role they played in the debacle, lenders have been slow in returning to the home lending market. Both home buyers and investors face more rigorous borrowing standards. Meanwhile the government rolls out new programs intended to reinvigorate the market.
For now these are obvious consequences of bubbles and corrections; the pendulum swings in a sort of dialectic. Is this the New Normal? Economists disagree. Optimists, the National Association of Realtors (NAR) among them, argue we are on the verge of dealing with pent-up demand. Others suggest broader economic factors, in particular lagging increases in household income and changing household formations, will continue to restrain increases in housing demand and home values.
"New Normal?" Or Is It The Old Normal?
More likely is the proposition that the new normal is in fact a return to the Old Normal. That after the run-up of the Bubble and the collapse of unsustainable values (now deemed a 'recession'), we have returned to the historical rate-of-inflation-plus-1% of the last 100 years. Viewed in this way, the recession is over–
Home values are now at or approaching the 3.1% average annual home value increases that would have been realized had the Bubble and Correction never occurred. The key indicator for investors is better pegged at: rate of inflation plus about 1%. (Remember the maxim "real estate is your best hedge against inflation"?)
To be sure, local or regional economic shifts will influence home values above or below this standard. Loss of manufacturing jobs, changes in transportation options (development of the interstate highway system during the 1950s), neighborhood gentrification–all will influence local economic conditions and property values, positively or negatively.
Such changes take time, take longer; there is little to surprise. And where one locale may experience decline, another is generally on the rise. It is in studying–or at least being alert to–such localized changes that investing opportunities are found.
While we are at once both aided and constrained by Change, it is always best to "take the long view". To quote the modern bard, Bon Jovi, "The more things change, the more they stay the same..."
- Philip Elmes