Home Blog Prices Should Not Fall Much Further in Many Markets

Prices Should Not Fall Much Further in Many Markets

Written by Jonathan Smoke

12.28.2007

Discuss this article on the forums. (0 posts) Yesterday I wrote about the ridiculous position that home prices must decline until homes become affordable -- as if a home’s value is solely determined by what a median household can afford to pay for shelter. Is the price of gasoline governed by the same rule? Can you come up with anything that’s price is governed by what a median household can afford to pay for it? Maybe french fries in aggregate, but even fries cost a tad bit more at a ball park than at your local McDonald’s. Now of course when it comes down to an individual home being sold, the buyer must be able to afford it. This is especially true (again) now that easy credit has disappeared. But home prices for a market reflect the distribution of homes sold, which in turn reflects a broad spectrum of incomes. Higher prices for homes can be supported by several reasons: Incomes increasing across the board Incomes increasing for those who are more likely to buy homes Higher income households moving into a market Households determining they can afford to spend more on a home as a tradeoff for something else that is less important to them; i.e. some households will spend more on a smaller house closer to work than others who would accept a long commute in exchange for getting the most housing value for their money Speculation activity There’s no doubt that home prices can be driven higher very quickly as a result of speculation activity. Despite the fact that I find myself somewhat alone in saying that the future isn’t as grim as many are predicting, I do not contest that there were housing bubbles in several parts of the country. In many places home prices rose far more quickly than they likely would have without rampant speculation and loose lending practices. However, prognostications about definite further home price declines in every market raise my suspicion. For one thing, home prices didn’t go up everywhere; and in many markets where prices did rise, they certainly didn’t rise at a pace that would imply a bubble. My own home market, Atlanta, missed the boom. Yet some would lead you to believe that even Atlanta is likely to see double-digit price declines. True Home Price Forecast To dig into a better definition of bubble markets vs. non-bubble markets, we created a simple model to forecast home prices. We then back-tested actual home prices to predicted price levels and measured the peak difference between 2002 and 2007. The result? We found 156 MSAs where the median existing home prices reached a level over that 5-year period, which indicated some level of speculation was likely occurring. However, we found only 82 that exhibited more than one standard deviation above the mean difference for all markets over the same period. We consider these to be the markets that reached the true inflated bubble condition. The usual suspects landed on this list including Honolulu, Riverside-San Bernardino, Los Angeles, Sacramento, Fort Myers, Miami, Orlando, Reno, Las Vegas, and Washington, DC. Where was Atlanta? Nowhere near the “frothy” markets. Atlanta’s home prices didn’t exceed a normal expected range. Must All Home Prices Decline? This week we heard from S&P/Case-Shiller that home prices have fallen year-over-year in the 10 and 20-city composites and in 17 of the 20 markets covered by the repeat sales price index series. Atlanta is one of those 17 cities and it had a decline of 0.7% over 2006 according to the October 2007 index. In the same way that many liked to sound the alarm that home price increases were defying the laws of nature, let me be one of the first to say that these declines we are starting to see in markets like Atlanta are unsupported by the market fundamentals. The primary factors that could be causing these declines in healthy non-bubble markets like Atlanta are lack of credit and poor consumer sentiment regarding the housing market. So isn’t it ironic that the very media that fueled the interest in flipping homes is entrenching the thought that prices will inevitably decline in the minds of consumers? It seems that even what didn’t go up must be hammered down. Don’t believe me? Check out research published this month from Global Insight / National City Corporation. Using the same models and methods they employed to warn about overheated markets at the height of the bubbles, their research now indicates that most markets are fairly valued or undervalued. Like our own analysis, the Global Insight/National City research identified mostly coastal markets as still being at least moderately overvalued and therefore likely inclined towards further price declines. In the same way that the Dot Com bubble burst and took the Dow and S&P with it at the beginning of this decade, markets like Atlanta that saw no bubble are getting punished just like those markets that saw incredible price increases. Therefore, fairly valued or undervalued markets with good prospects (e.g., not Detroit) represent great investment potential, assuming you do your homework on local supply and demand. The consumer malaise won’t last forever, and liquidity will be restored once lenders start to see some stability in prices. Prices have already fallen more than they should have in non-bubble markets and are likely not to fall much further barring economic decline. Don’t be fooled to believe that bubble markets represent the majority of markets. The media just like to write about them. We're always looking for feedback from our readers. There are no comments for this item. Please login or register to post comments. J! 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