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. Realtytrac.com 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.