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It's possible that housing prices are much higher for good, because real estate was historically undervalued. I know, I know, hear me out ;) I remember readin
by geebee 14y ago
It's possible that housing prices are much higher for good, because real estate was historically undervalued.
I know, I know, hear me out ;)
I remember reading an article during the housing boom that made a very interesting argument in defense of the high prices. It was wrong, of course, but it was different from the usual "there's never been a better time to buy... or sell!" crap you heard from the real estate PR machine. It was a pretty sober look at the numbers.
The argument boiled down to this - if you're going to compare current prices to the historical trend, you need to exclude the possibility that real estate was undervalued before you can conclude that current values are overvalued purely based on divergence from historical trends.
The paper argued that housing was historically undervalued because creditworthy people didn't have good access to credit. A house required a 20% down payment, and banks (back when banks held a loan for the entire life of the loan) wouldn't allow income to debt ratios to exceed a certain threshold. They argued that new methods to spread risk across larger pools allowed the extension of larger amounts of credit without a huge jump in risk.
An example was a loan made to two nurses with excellent credit earning a combined income of well over $200k, but who only had about 20K in down payment. In the past, this 10K would have limited their purchase price to 100K. Now, they could bid much higher - without, as the article described, a massive increase in risk to the lender, especially if that risk could be spread.
It was a well-reasoned argument, and I think what it missed was the profound level of corruption and dishonesty going on in the industry at the time. As we all know now, and as our wise leaders like Greenspan should and could have learned while they were reassuring everyone things were just peachy, is that the "two nurses" example was not at all typical of these "higher risk" loans, and the "spreading of risk" was in fact a way of dividing up and obscuring risk to make horrendous loans look better (and package them up and sell them, and then bet against them).
But this phenomenon will probably continue. Yes, housing prices are higher, but I suspect that once the dust settles, some of these "innovations" (my disgust with the industry makes it hard to use that word) may actually come into play.
In short, we may pay more for houses than our elders did, but we may actually have better, more efficient access to credit in the long run (I want to make sure nobody thinks I'm defending the antics of the banking sector during the bubble with this argument).
Oh lastly - I do apologize for no cite. Can't really remember where I read this...
- Retric 14y agoThe fact that the majority of people buy their homes though loans leads to a wide range of price distortions. I would argue housing increased in price faster than inflation in large part because the FED was so effective at reducing inflation which reduced interest rates. A 30 year loan could see the borrower paying 2x the houses initial value as interest, so if you drop that down to 1x suddenly people can afford to pay significantly more for a house. This, lead to people being easily able to afford the house, but unable to make the 20% down payment. Which lead to 'risky' loans being safe for a while. Thus, a lot of automated risk systems only had good data for during a historically long period of increasing housing prices and decreasing interest rates.
- dredmorbius 14y agoThat's an interesting theory. Comparing purchase to rental prices pretty much blows it out of the water, however.
- malandrew 14y agoI'm interested in hearing more on this point.
- dredmorbius 14y agoBriefly, look at a "buy vs. rent" calculator. If the costs of renting, inclusive of any possible foregone appreciation gains from real estate, are lower than of buying, then the economically rational choice is to rent, not buy. In urban economics, the value of housing is largely dictated by the potential income one can acquire by virtue of holding it. That is: housing reflects the local prevailing wage. It makes zero sense to rent a property (as a wage earner) for more than one can make in income living in the area. Hence, rents tend to be much more responsive to wage inflation/deflation than housing prices (student and retirement housing would be exceptions, but they're constrained by similar functions ultimately). With real estate, there is the potential for appreciation gains. This presumes, however, that there's someone willing to buy at the appreciated property later. Housing prices cannot inflate indefinitely over other assets. And the long-term historical return on housing (since the 1880s or so in the US -- period for which data are available) are in fact lower than most forms of investment. Housing carries heavy costs: taxes, maintenance, improvements, etc. And it's largely an illiquid asset, particularly for the small investor (I may have many of a smaller investment to sell, I generally only transact in a single house at a time). There are other tweaks on this: rental/owner-occupied housing aren't perfectly substitutable (covenants, HOA restrictions, etc.), there are non-financial returns to housing (or at least longer-term returns), notably school district access and crime/safety rates. In markets with low vacancy rates, rental values may fluctuate more broadly. Bank lending practices may make buying easier (2000s) or harder (2010s) at any given time. But the upshot is still: rental prices in a given market tend to be a better guide to local economic conditions than real estate prices.