September 21, 2010
Several prominent analysts have written recently that the bear market in housing is nearing its end. Writing with varying degrees of conviction and citing a range of statistical measures, they reach the broad conclusion that now is the time to buy a house.
What follows is a summary of those opinions – from James Grant of Grant’s Interest Rate Observer, Dave Leonhardt of The New York Times, and Anatole Kaletsky of GaveKal Research. To those voices we could add Karl Case, the co-creator, along with Yale professor Robert Shiller, of the Case-Shiller Housing Index, who two weeks ago said that it was the best time to buy a house “in the last four, five years, and maybe in my lifetime.”
My view, though, is considerably different and far more pessimistic. As I will explain, I am not alone in forecasting that residential housing prices will continue to deteriorate, perhaps significantly, at least over the short term.
The bull case for housing
In the July 9 issue of his publication, James Grant reviewed three metrics supporting his claim that “house prices are cheap, very cheap, or fairly valued, respectively, according to the valuation method employed.” Grant’s first metric was the calculated transaction value (CTV) – the average house price times the number of houses sold, divided by the GDP. Essentially, it represents housing’s share of the GDP. At the time of his writing, the CTV was 8.7%, compared with an average of 9.8% since 1970. Housing, by implication, should revert to its mean relative to GDP, and house prices should rise.
Grant went on to say that housing is now highly affordable by historical standards, citing the National Association of Realtors index. That index, which measures the ratio of median income to median housing costs, stands at 174.8, while its long-term average is 127. More people can afford houses, and that too should drive up prices.
Third, Grant cited 50 years of data on the ratio of rental income to housing prices, which, currently at 5%, is nearing its historical average. That ratio had descended to approximately 3% in early 2006, at the peak of the housing bubble. Relative to renting, the decision to buy a house is now an even tradeoff.
Grant added, however, that his view is tempered by the uncertainty of additional housing that might come on the market through the foreclosure process. Grant noted that “as many as seven million mortgagors are delinquent or in foreclosure and will eventually be liquidated.” I will return to that point later.
In his September 7 article, The Bears and the State of Housing, Dave Leonhardt wrote that homebuyers planning to stay in their homes longer than a few years “should take some comfort in the fact that the bubble seems mostly deflated. Sometime soon, prices should begin rising again.”
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