Freakonomics Quorum: Is It Time to Believe in the Housing Bubble?
Following last week’s quorum about street charity, we’ve now brought in a half-dozen bright people to address a very different issue:
Is it finally time to believe in the housing bubble? And how much should the average American care?
While the topic of real estate has hardly been neglected on this blog, the housing bubble is another story. Here to tell the story are:
Robert Shiller, the Yale economist and Irrational Exuberance author, who has indexed U.S. home prices back to 1890; Lawrence Yun, chief economist of the National Association of Realtors; David Lereah, the N.A.R.’s former chief economist, who is now executive vice president of Move, Inc.; Barbara Corcoran, the real estate maven and author; Aviv Nevo, a professor of economics at Northwestern and a co-author of a study about FSBO (for sale by owner) sales versus sales via a realtor; and Amir Korangy, founding editor of the very good New York City real estate publication The Real Deal. Here are their replies:
We have been in the biggest housing boom this country has ever seen, and it is not just in the United States. [The boom] has affected many of the world’s most successful economies, and has clearly been driven, at least in part, by extravagant expectations for future price increases. Such expectations tend to be found in countries where the economy has been strong enough to make high future price increases seem plausible to investors. In these countries, people are buying homes even though they have gotten very expensive, because the buyers believe that prices will rise even more. That attitude can sustain a boom for a while, but not forever.
My colleague Karl Case and I have been surveying U.S. homebuyers about their expectations. In 2005, at the height of the boom, the median expected home price increase in Los Angeles was 10% for the next year, and 9% a year for the next decade. Clearly, these were very strong expectations, and such expectations appear to have contributed to the boom itself, because it enticed people to buy properties in anticipation of making a lot of money in capital gains.
In 2007, the median expected home price increase in Los Angeles was 0% for the next year, and 5% a year for the next ten years. As such, expected price increases are weakening, but they are not gone yet. It is not clear whether the boom has come to an end; there is still investor enthusiasm out there.
Meanwhile, the Standard & Poor’s/Case-Shiller Home Price Indices which Case and I pioneered are now showing price decreases in most cities. This raises a question of how long expectations of increase can co-exist with falling prices.
In May of 2006, the Chicago Mercantile Exchange launched futures and options on our indices for ten U.S. cities, with a maximum horizon of one year. In September, the horizon will be extended to five years. We will then have a clearer picture of market expectations for home prices. For now, it is worth noting that the market is predicting home price decreases between 3% and 8% for the next year.
Should this matter to home buyers? Certainly. Buying a large house with a mortgage can be a devastating move if home prices fall by more than the down payment; all home equity could be wiped out. On the other hand, people need to live somewhere, and most are not happy with renting. They need to buy a house and get on with their lives.
Some of these people might consider hedging the home price in the futures or options markets, though any such move is complex and should be done only with the advice of a competent financial advisor.
We would advise your readers to visit the N.A.R. website to see our research on the housing market. All real estate is local, and there are many local variations.
As to the bubble, quite a number of local markets have not seen any price decline. The “correction” has been in home sales, mortgage lending, and new home construction, all of which are all down significantly. Some bad lenders have gone bankrupt, and aggressive hedge funds are hurting as a result — and I, for one, do not care. What I do monitor carefully is a factor that matters to consumers and homeowners: home prices. The national median price was 1.1% lower in the second quarter of 2007 than its comparable period the year before. That drop comes after a more than 50% rise in home values during the boom. If people want to call the 1% price decline a bubble collapse — well, everyone has an opinion. I believe that homeowners who are in it for the long term will do well. The Federal Reserve data show that the typical median wealth holding is $184,400 for homeowners, versus only $4,000 for renters. That, in my view, is quite compelling.
Bubble is the wrong imagery for today’s housing markets. Bubbles inevitably “pop.” A more useful image for the housing markets is a balloon. Balloons expand and deflate. It is clear that air has come out of a number of local balloons across the nation, particularly in California, Nevada, Arizona, Florida and some selected metropolitan areas in the Midwest and Northeast regions. From a home sales perspective, the magnitude of today’s real estate downturn is not meaningfully different from our two most recent real estate downturns – 1990/91 and 1980/81. For example, the 80/81 recession resulted in a 48% drop in existing home sales. Existing homes sales have dropped by less than 20% so far in the 2006/07 downturn. However, unlike real estate recessions in the past, today’s downturn offers two unfortunate residuals – a drop in home prices for the nation as a whole, and a serious run-up in foreclosures.
If a national bubble had burst, the nation would have experienced a meaningful double-digit drop in home prices. To date, we are experiencing maybe a 3 to 4% drop, at most. But for some post-boom metros like Las Vegas, Miami, and Phoenix, double digit price drops are not out of the question. So the answer is that there have been some local housing balloons that have popped, but no national balloons.
How much should the average American care? If you purchased property in 2005 or 2006 in one of the “booming” metros that have now gone bust, you care a great deal, because you have most likely lost equity in your property. But home prices appreciated 34% during the 2002 – 2005 period; as such, even a 5 to 10% national price drop will not meaningfully impact most homeowners, since they have built up a sizeable amount of equity in their primary residences.
There’s a hell of a lot of noise out there right now that would scare anyone away from buying real estate. Not me. I’m yahoo-ing, low-bidding, and snatching up deals wherever I can find them. I understand the two big truths about real estate investing:
1. Everybody wants what everybody wants!
2. Nobody wants what nobody wants!
So until everyone else decides (always at the exact same moment in time) that the worst is over and it’s safe to invest, I’m grabbing as many over-priced, over-stuffed, and over-rated homes as I can get my greedy little hands on.
I don’t know if it is time to believe in a housing bubble, and, frankly, I am not sure the average American should care. Let me explain. Anyone considering buying or selling a home any time soon should care about future prices. If you are thinking of selling, you should wait if you think prices are going to go up. If you are buying, you probably want to do so sooner, and maybe offer a higher price if you expect prices to rise. So, clearly, what you think about future prices is important. However, even if there is a chance to time the market — and I am not sure there is — I doubt the average consumer has the flexibility or forecast ability to consistently take advantage of it by timing the purchase or sale of a home. Of course, some homeowners are going to be lucky, and some less fortunate. But for the average American, there is little to be done except worry.
On the other hand, there are other ways that consumers can increase their gains from real estate dealings. The most obvious is to avoid using realtors. That’s a 6% savings right there. (Despite what realtors would have you think, there is no credible evidence that they get you a higher price.) My guess is that, given the constraints most consumers face, the 6% in saved commissions is more than the average person could gain by trying to time the market.
Ah, the age old question. Short answer: no. In various markets around the U.S., prices have appreciated in a huge way; but this doesn’t necessarily mean we’re experiencing a bubble. Real estate prices are a local phenomenon based on employment, industry, and other factors including climate, quality of education, cost of living, immigration, and crime. Therefore, if the concept of a national housing market is ultimately a false construct, there simply cannot be a national housing bubble.
As recently as 2004, there was a lot of media speculation about a housing bubble. Back then there was a slowdown, but not an across-the-board bubble. I wouldn’t forecast such an outcome occurring now in New York City. One contributing factor [to New York’s market strength] is the city’s popularity with the rest of the world, as well as the weak dollar, which has increased foreign investment.
Let’s talk about what a bubble is. A bubble exists when the ratio of median existing home prices is about 6 or 7 times greater than per capita income. If you compare the census with prices in New York, they seem reasonable. Bubbles have certainly existed in particular regions, and prices in those areas could be brought down by a range of factors. In 2005, when the entire country was experiencing tremendous real estate growth, prices in Canton, Ohio dropped continually. Drops like that contradict market fundamentals, increasing speculation and participation in the market by people who normally don’t get involved in such things … and, as a result, have a tendency to become a topic of popular discussion.
What Americans should worry about is the vast, across-the-board slowdown in residential property investment. Of the many scenarios that contribute to this, one that is already in play occurred when real estate-related jobs, which had been in tremendous growth mode, began to tank. As a result, we saw less new development and less stabilized prices. House prices can start to decline, making it harder for people to refinance their loans and causing a negative impact on consumer spending. This is how recessions begin. As such, it would be good if the Fed lowers interest rates soon.
A burst bubble would impact different cities differently. In places like New York City, which continues to attract tens of thousands of immigrants and has a healthy financial sector, prices could recover faster. Indeed, in that sense, a bubble (if that’s what you want to call it), is helpful because it helps to expand the number of units on the market.