| The Price of Oil and Home Sales Are Not Directly Related |
| Written by Jonathan Smoke | |
| 08.13.2008 | |
Discuss this article on the forums. (0 posts)  Twice in the past week I have been questioned by clients about the price of oil’s impact on housing and the current housing downturn. It’s easy to see why. Until its recent retreat, the price of crude oil had more than doubled in the last year. Since new construction, home prices and home sales have tanked in the last year, the conclusion is that the price of oil is part of the problem.And worse, when I pressed one client’s source of concern I learned of a local housing market expert who recently told a group of builders and developers that the price of oil had to retreat to less than $100 per barrel for things to get better. Poppycock! A pox on this wizard’s advisory business for making people think that there is a tight connection and more importantly that some arbitrary price level of oil like $100 has any influence on home sales. I turned to my colleague Bill Russell to shed some economic light on the historical relationship between home sales and the price of oil. First he looked at the price of oil relative to new and existing home sales as the two charts below illustrate. For both new home and existing home sales, there is no clear relationship with oil since most of the housing boom occurred under rising prices. There is certainly nothing special about the $100 barrier. Now let’s look at the growth rate of the price of oil relative to the growth rates of new and existing home sales. The oil and new home sale growth scatter above does show that as the price of oil goes up, new home sales fall, but this relationship is weak (R2=.05). It implies that if the price of oil goes up 10% over a year, new homes sales will fall by about 1% relative to no change. Likewise, the oil and existing home sales growth scatter above shows that as the price of oil goes up, existing home sales fall, but this relationship is also weak (R2=.11). It implies that if the price of oil goes up 10% over a year, existing homes sales will fall by about 0.67% relative to no change. Bill’s conclusion: there is a weak negative relationship between oil and home sales according to these two simple data sets, but I am confident this relationship would not hold up to a more thorough economic review with a better specified model. My take is that the housing market boomed as oil got more expensive in the earlier half of this decade. Then the housing market was well on its way into decline before oil started its rapid ascent. Would-be home buyers have not put off buying because of crude oil. They may be more focused on energy efficiency (and they are!) and they may think twice about trading off a shorter commute for a bigger house, but they aren’t sitting on the sidelines waiting for oil to fall back below $100 a barrel. While the pinch that we are all feeling at the pump does have an impact on consumer sentiment (and sentiment is no doubt a part of the current depressed demand), falling home prices, foreclosures, tight credit, and relatively high inventories are much more related to the dismal performance we’ve seen in 2007 and 2008. Furthermore, in markets like Atlanta we are likely close to if not already past the bottom as prices appear to be stabilizing and inventories, especially of new homes, are slowly working down. So just because oil prices have recently started to tumble, don’t believe for a second that this tumble is what caused things to get better. Or if you do, maybe you should get your advice from wizards or used car dealers. 
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