Sunday, January 18, 2009

Housing market still on red alert, but there are signs of stabilization

The housing market - the epicenter of the credit crisis - has yet to stabilize: prices continue to decline; starts are at record lows, and are expected to fall further; and the inventory build in the existing home market remains at troublesome levels; and then there is the shadow-inventory that looms.

US policymakers are moving on with their bank bailout plan , which is now centered on the assets that derive value from the housing market. The pending question is: when will home values stabilize?

Since renting and owning a home are substitutes, economists often use the price (home values) to rent ratio to determine the relative value of home ownership. Generally, as the price-rent ratio rises above its trend value, then home ownership becomes more over-valued (the opposite is true for a lower than normal price-rent raio).

The chart illustrates the national price-rent ratio, which is calculated as the quarterly home price index (either OFHEO or S&P Case Shiller) divided by the Bureau of Labor Statistics' owner-occupied price index. Into the third quarter of 2008 (the latest data point), home values were still very much overvalued compared to renting, indicating that national prices still have some downward momentum to go.

But at the city level, some price stabilization is afoot.

The chart illustrates the third quarter 2008 deviation of price-rent ratios across all 54 metro areas in the U.S. (the data come from this Time article, where about 2/3 of the way down, you will see the link, click here) relative to their 15-year averages. There is a sense of over correction in key cities, where the price-rent ratios in Cleveland, Riverside-San Bernadino, and Detroit are 18.7%, 16.7%, and 15.3% below their long-run averages. These markets would be considered hot buys in normal economic times.

A correlation with foreclosures? Sure (source: Realtytrac).

The chart illustrates the 10 states with the highest new foreclosure filings for December 2008. reports that 2008 saw 2.3 million foreclosure filings, which is 81% higher than in 2007 and 225% than in 2006. Except Except for Indianapolis and Kansas City, each metro area that is overvalued is in either California and Ohio, or top foreclosure states.

Foreclosures are pushing prices down, and this sort of price discovery (finding an equilibrium where supply meets demand) is a necessary evil in market corrections; but some markets have over-corrected. The good news: states like California and Ohio may be seeing stabilization in their housing markets.

However, some states are set for further corrections. Cities in New York (New York-White Planes), Maryland (Baltimore), Virginia (Richmond), Florida (West Palm Beach, Jacksonville), and North Carolina (Charlotte), for example, have price-rent ratios that are still at least 24% above the long run averages.

Rebecca Wilder


  1. A price skew upwards for rent is maintained by the harsh reality that landlords generally do not lower their rent as market conditions change. When times are difficult for tenants, it is more likely that an unofficial renter, or long term "guest", will be found in the front room, sleeping on the couch, and a hungry landlord will turn a blind eye. In Canada, we have a so called "renter's assistance" for lower income families. It is means tested, and paid directly to the tenant. Guess which way the rent goes? The renter's assistance becomes landlord's assistance.

  2. HI Charles,

    Thanks for the comment! I would argue that rent is moving in the downward direction, with a larger share of new sales going as investment properties. Foreclosures being bought at rock-bottom pricing may drive down rents. One thing is for sure, there are a lot of moving part (the equilibrium) in this market right now, and nothing is certain.


  3. I take your point. However, as a simple supply/demand consideration, one has to ask where the folks who used to own and live in those foreclosed homes are now living? If they are forced to rent.., well, it's easy to connect the dots.

  4. Being a renter, I can say that houses on the selling market here are being rented out while they sit and wait. Renters are shorter term snowbirds but better some rent than none and it is definitely a bargain. It will be back to normal by May with so many houses on the market and more popping up all the time. Few are selling. That may indeed be where the former owners are landing. We will wait to buy for a while as prices are still falling.

  5. Yes, the devil is in the details. Your point about "snowbirds" is exactly how even the term "rent" can morph into a measure of what it costs to take a holiday. A real world consideration of how inflated housing prices were, and still are, would be an external reference measure. For example, assuming baristas and minimum wage earners don't "deserve" to own unless they have a huge downpayment, an interesting measure would be replace the "home values to rent ratio", with "home values to wage ratio", using the average wage of a journeyman plumber, plotted from the 1950s to present day.

  6. As with most subjects this one is much more complex than simply talking about rental v.s. for sale buildings. In a great many cities over the past decade there has been a near freeze on the construction of new rental properties. City boards and councils preferred upscale ownersas opposed to renters. So most of the available apartments are in buildings that have been paid for years ago where the owner suffers nominal pain as the result of a few vacancies. In those instances I don't see the rental rates changing.
    For the few new faciltites those owners have financing obligations so they may be more flexible to adjust from asking rent to what can we get by with rent.
    Regardless, with millions of foreclosures there is going to be one heck huge shortage of rental facilities in the near future.

  7. It can be good if the house prices would fall. the houses for rent in golders green prices is cuntinue to go up.