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Housing Bubble: The Story Is Sale Prices, Not Rent
The NYT article on the release of the April CPI notes the moderate 0.2 percent rise in the rental indexes,
prompting the comment from Ken Mayland, President of ClearView Economics, "The question that raises is whether the big cyclical downturn in the housing industry is finally cooling shelter costs.”
This comment is a bit peculiar. Rental prices never rose much more than inflation over the last decade and have generally trailed the overall rate of inflation over the last four years. It was sale prices that had soared. Economists typically expect the two to follow the same general path. The story of the bubble is the sharp divergence between sale prices and rent over the last decade, which indicates that sales prices were not being driven up by fundamental factors in the housing market.
--Dean Baker
COMMENTS (11)
Well, there was also a sharp decrease in long-term interest rates over the last decade as well, which explains a lot of the divergence, if not all of it.
Posted by: Felix | May 16, 2007 9:55 AM
The consensus among wiser heads than me in the bubble watching blogs is that housing will not have returned to normal until house prices return to about 120 times monthly rent (so that renting a home is somewhat cash flow positive).
Using rents instead of house prices for "core inflation" is just silly. Barry Ritholtz makes fun of this and the exclusion of "volatile" energy costs over at his The Big Picture blog.
By the way, congratulations on this post being No. 1 on Google News |housing bubble| search this morning.
Posted by: John M | May 16, 2007 10:59 AM
I had a brief position with a real estate investment/property management company. In our model we would buy houses that we could rent at a 5-6% cap rate, this would not generate cash flow for our investors, but it would keep the carrying costs well under the expected appreciation. What we found is that we were limited to a particular price band. To get the kind of renters we wanted we needed a 3 BR 2 BA house, which estabished a price floor, on the other hand there is a natural limit on how much rent you can extract before buying becomes a cheaper option for your prospective renter. This in turn established a ceiling price for us.
Which is why I question the premise that you can have a rule of thumb like 120 months of equivalent rent. Part of the problem is that prices vary a lot more than income. Postal carriers in Spokane getting paid the same as they do in Los Angeles while the prices of housing are much lower.
I don't think you could ever get prices down to 120 months of rent in a lot of markets or even within a market. Some housing is simply not rentable, there will always be a price point that exercises the squeeze out that moves renter to owner, to argue from that to suggest that all houses over that price point are over-priced to say the least yields poor real world results.
I do not believe it is possible to establish a pricing model nationally, each market is different. As an example our model was appreciation based, it would have failed disasterously in Detroit and never could have worked in Los Angeles. In Detroit we couldn't have got the appreciation and in Los Angeles we couldn't have got the rent.
Which is to say that while there is a relation between rent and price, at some point in every market that relationship will break down, that house will move out of the world of investment real estate and firmly into owner-occupied where the relationship transforms to price to income, (not just on a practical basis but also as a condition of financing).
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