Here is a great article from the New York Times, written by Karl Case, one half of the duo who bring us the esteemed Case-Shiller Index each month – a national measure of housing prices. In his op-ed, Case points out clearly and insightfully the delicate relationship between consumer confidence, demographics and the housing market, as well as how our definitions of the “American dream” vary and may need some re-interpretation.
A Dream House After All
By KARL E. CASE
Published: September 1, 2010
IF you read the coverage of the latest figures on the sales of existing homes from the National Association of Realtors, you may well have come to the conclusion that the American dream is dead. It is indeed worrisome that sales in July were down 25 percent from a year ago.
But a little perspective is in order.
First, the bad news. What has happened in the housing markets since 2005 is a catastrophe that may take years for our economy to recover from.
Anyone who believed that home prices never fall has learned a tough lesson. The Case-Shiller price indexes released on Tuesday suggest that since their national peak in 2006, home prices have fallen by 29 percent. Some areas of course look better than others. Las Vegas is down 57 percent from its peak and Phoenix is down 51 percent. On the other hand, Boston is down just 13.5 percent and Dallas only 4.2 percent.
The effect on household wealth has been huge. Data maintained by the Federal Reserve show that the value of residential real estate directly held by households fell to $16.5 trillion in the first quarter of 2010, down from $22.9 trillion in 2006. It has yet to be determined who will end up bearing those losses. The decline in wealth has substantially reduced consumption, stifling the economy.
Depressing, yes — but the end of a dream? Not exactly. I have never quite understood what the American dream really means when it comes to housing. For some people, it means having a solid and fairly safe long-term investment that is coupled with the satisfaction of owning the house they live in. That dream is still alive.
Others, however, think the American dream is owning property that appreciates by 30 percent a year, making a house into a vehicle for paying bills. But those kinds of dreams have become nightmares for the millions of foreclosed property owners who have found themselves sliding toward bankruptcy.
But for people with a more realistic version of the American dream, buying a house now can make a lot of sense. Think of it as an investment. The return or yield on that investment comes in two forms. First, it provides what is called “net imputed rent from owner-occupied housing.” You live in the house and so it provides you with a real flow of valuable services. This part of the yield is counted as part of national income by the Commerce Department. It is the equivalent of about a 6 percent return on your investment after maintenance and repair, and it is constant over time in real terms. Consider it this way: when Enron went belly up, shareholders ended up with nothing, but when the housing market drops, homeowners still have a house. And this benefit is tax-free.
The second part of the yield on investment in a house is the capital gain you receive if it appreciates and you sell the house. Gains are excluded from taxation if the property is a primary residence and the gain is less than $250,000 for a single filer or $500,000 for a married couple filing jointly.
Consider a few other bonuses of buying a home today. You can deduct the interest you pay on the mortgage. Interest rates are about as low as they can get. And, don’t forget, home prices are down by 30 percent on average from the peak. The mortgage-interest deduction and the tax-free income from housing cost the government at least $200 billion a year.
During this recession the government has been doing even more on behalf of the American dream. It offered a tax credit of $8,000 to first-time buyers, and eventually $6,500 to other qualified buyers. Not only did the Federal Reserve continue to keep the short-term interest rates it sets at essentially zero, it purchased $1.4 trillion in mortgage-backed securities so that lenders could keep mortgage rates low.
Do the math. Four years ago, the monthly payment on a $300,000 house with 20 percent down and a mortgage rate of about 6.6 percent was $1,533. Today that $300,000 house would sell for $213,000 and a 30-year fixed-rate mortgage with 20 percent down would carry a rate of about 4.2 percent and a monthly payment of $833. In addition, the down payment would be $42,600 instead of $60,000.
In fact, until about two months ago, it looked as if potential buyers were beginning to understand all these advantages and that the market was turning around. By May 2009, housing prices had stopped falling in a majority of the metropolitan areas surveyed in the Case-Shiller index. Sales were also up. In 2008, 4.9 million existing homes were sold. In 2009, the figure rose to 5.2 million; last November, sales hit an annual rate of 6.5 million (a boom-time number). Even new construction showed a pulse.
So, what happened to kill the momentum? For one thing, the first-time buyer credit expired at the end of April. And some longer-term demographic changes may also be affecting the housing market.
In the next several years, the Census Bureau and other demographers project that the number of American households will increase by 1 to 1.5 million each year. With new construction sagging, we should be experiencing a tightening market with low vacancy, as has occurred in every housing cycle since World War II. But instead of falling, vacancy rates remain at near-record levels.
My guess is that the number of households has not been growing as much as projected and may even be falling. We won’t know for certain until the 2010 census is complete. This figure depends on many factors: immigration, emigration, the age distribution of the population and the number of young adults staying at home or doubling up. Unemployment is high, and we know that without jobs people tend to move in with Mom and Dad. And we don’t make immigration easy, even for those with advanced degrees who would be most likely to enter the housing market. None of this bodes well for a quick recovery.
While demographic trends are uncertain, one important reason for the recent downturn is clear: The steady drip of bad news about the economy has sapped the confidence of buyers, sellers and lenders. And there is no understating the importance of expectations and confidence in this industry.
Real estate sales are unlike other financial transactions. You can place a rough inherent value on a stock or bond by looking at fundamentals: a company’s profits, price-to-earnings ratios, quality of its products and management, and so forth. But a house is worth what someone is willing to pay for it. That’s a very personal, emotional decision.
And emotions can change on a dime. To try to track moods and expectations as part of our Case-Shiller data, the economist Robert Shiller and I send out 2,000 questionnaires each year to recent homebuyers in San Francisco, Los Angeles, Milwaukee and Boston, asking them what they think is likely to happen to the value of their houses over the next year.
In 2005, respondents felt on average that prices would rise 9.6 percent. In 2008, they anticipated a small drop. In 2009, the figure turned positive again in all four cities, with an average anticipated gain of 2.2 percent. We have just tabulated this spring’s survey, which found that homebuyers anticipate a gain of 5.2 percent in the next year.
In a given year, the number of completed sales is about 4 percent to 5 percent of the housing stock. Thus it doesn’t take a change in mood of a large number of buyers to change the overall direction of the market.
This financial crisis has made us all too aware that we live in a Catch-22 world: the performance of the housing market drives the economy, and the performance of the economy drives the housing market. But housing has perhaps never been a better bargain, and sooner or later buyers will regain faith, inventories will shrink to reasonable levels, prices will rise and we’ll even start building again. The American dream is not dead — it’s just taking a well-deserved rest.
Karl E. Case is a professor emeritus of economics at Wellesley and co-creator of Standard & Poor’s Case-Shiller housing index.
A version of this op-ed appeared in print on September 2, 2010, on page A35 of the New York edition.