This months edition of Fortune Magazine (November 12, 2007) had a great article on housing called How Low Can They Go? by Shawn Tully (no online link available yet, but I’ll modify post once it is). It combined extensive analysis of 54 metro housing markets with the combined work of Moody’s Economy.com, Fortune Analysts, PPR, & NAR. The basis of the article was to provide a snapshot of what the future of housing will look like in 5 years from June 2007. They determined a correction value (sometimes positive) by comparing present day price to rent ratios with the average of the past 15 years.
“In most markets people won’t lay out much more in monthly costs to own a house or condo than they would to rent a similar property unless they expect a huge profit when they sell. Indeed, speculators chasing quick profits did a lot to inflate the recent bubble. But once the fervor fades, prices must fall to restore their normal, long-term relationships with rents. Rents exercise a kind of inevitable gravitational pull on prices. The ratios of price to rents behaves much like price/earning ratios for stocks says Yale economist Robert Shiller. Like P/E’s, price-to-rent ratios are mean-reverting. In other words, while prices soar from time to time sending the ratio to exceptional heights, sooner or later the relationship is bound to return to its historic average” (Fortune Magazine 78). To define the Price-Rent Ratio (P/R) it is House Cost/(Annual Rents) on the same house if rented.
The end of the article has a table which I meticulously copied number by number into excel to create a correction calculator and analysis of 54 metro markets. Us Baltimore bubble watchers are in luck as Baltimore was not only on the list, but was 5 of 54 where 1 will have the most decline and 54 will actually have appreciation. Greater Washington D.C. was 10 on the list. According to the analysis, Baltimore will exhibit a total P/R correction of -39.1% of which -27.8% will come from declining home prices and -11.3% will come from increasing rents; we renters aren’t getting out of this for free as many of us have hoped (including myself). I would attribute this increase in rents to an overall inflation pull on the economy causing major costs to increase. Most have already noticed this when you’ve been grocery shopping lately and as many have commented on lately P&G is raising prices up to 15% on some of their products and many of our staple items like milk are soaring in price. I expect this trend to continue, I just hope my paycheck keeps pace. If not I’ll remember to thank helicopter Benny for his handy work on creating stagflation.
This article also reported that construction costs are declining rapidly and the cost to build new homes has dropped about 10%. Also it talks about the rapidly increase property tax problem which will also be one of the factors causing downward pressure on home prices.
I’ve uploaded the correction calculator and analysis by metro area for all to use by clicking on this link you will be able to download the excel file. Instructions on how to use the calculator are in the file and you will be able to modify to be bullish or bearish on how the next 5 years play out. Please credit the work according if you plan on reproducing for personal use only and by using the work, you agree to that use is free, without warranty or guarantee of forward-looking statements and/or market conditions and by no means will this constitute as an offer of advice. The data that I copied from the Fortune article was reviewed many time to ensure accuracy, but I’m sure it is only accurate to the 000’s as that is what the data showed in the printed article. A few metro areas were off by 0.1% due to rounding to 000’s of the home prices.
Enjoy and please provide feedback as I spent a lot of time doing this project.
-Kevin
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23 comments:
Thanks. I love the fact that the P/R ratio is working its way into the average Joe's vocabulary now, just like the P/E ratio did after the 90s stock bubble burst. Some people still think that real estate is the best "investment", without having any tools to gauge it.
I hope P/R becomes widely circulated. How about passing laws to require MLS listings to post P/R, huh? What would that do for fairness and transparency.
Wow. Found this by way of calculated risk. Nice work, thanks for taking the time to do this. Even though I have followed the bubble pretty closely, I did know that the price/rent ratio for my market (Seattle) was so extreme. I wouldn't have guessed that Seattle had a similar ratio to San Francisco.
Anyway, thanks for going to all the effort!
Get a better file hosing service.
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awesome work!!
Thanks for the hard work! I live in Seattle & tell people we will go down, but they think we are immune. What they don;t know is Seattle tends to follow the national trend up/down by a 12-18 month lag. Our time is coming.
P/R is something I was exposed to some time ago. Nice to see more discussion about it!
Hello Kevin,
Great work. I had one question about this. Out here, you are working your way with a beginning price and estimating a downward correction.
A question here is - how do you arrive at a beginning price for houses ? I'd like to divide this question into two parts - for houses which have had a recent sale (past 4 years) and for houses which have not had a recent sale in the past 4 years ? How accurate are estimates provided by sites like zillow in this regard ?
Kevin,
Do you think that this works when adding more specificity? I live in DC. I moved out of an apartment about a year ago into a similar condo in a similar neighborhood (woodley park to Cleveland park) The ratio between my yearly rent and the purchase price was 15.3. (the average for greater dc was 15.9) Does this mean that in general, my condo will appreciate more or less in line with inflation? Or does it mean that I most likely get dragged down with everyone else?
-RobbL
RobbL,
That's a tough call. The downtown DC market is a lot different than the burbs. Comparing SFH's and condo's are tough.
From a historical standpoint condos are first thing to go down and the last to come up. And after Miami, there are more vacant condos in DC than anywhere else. Many a realtor will tell you that there is ridiculous amounts of new condo inventory in DC, Arlington, Bethesda, etc.
It's probably worse once you get outside the beltway as well. I went up the Rockville Pike a few weeks ago for the first time in 3 years, What I saw shocked me. Thousands of highrise condos have been built from White Flint to Germantown and they are mostly empty. To top it off, they are still building!
There is also that fact that condos are not an apples to apples comparison. Every building is different.
I am in a high rise condo building right over the Baltimore City line in very walkable community with the bookstores, restaurants and shopping all over. Most of these condos sold from 35k-70k in 1977-79. It took until 2002 for these condos actually started to "appreciate", till then the sales show most folks just getting there money back, a negative return inflation wise.
There is now like 10 for sale in my building and they are not moving. About 2/3's of them look stuck in the brady bunch 70's and in need of 30k-50k in renovations yet the sellers want the top dollar of a year ago that the gutted and stainless/granite/hardwood renovations were getting. (My current home is one of these units) Now nothing's moving.
This place is also is 30 years old and outside the nice renovated units, it definitely feels like a building that needs work. The garage needs repaved. The pool needs work. Elevators breaking down consistently, etc. From what I can tell, part of the reason is the really low HOA. The buyers of the next couple years are going to have to cough up some "special assessments" and major increases(probably 30-50% range) in the HOA fee to remedy the deferrals. This will cause the units go down and down in price. Many of the folks running the building are mostly at retirement age and really cannot afford the bump up that's needed to take care of the deferred maintenance.
Things like amenities, building maintenance history, HOA costs, and neighborhood all matter.
In the early 90's new condos went up in the Inner Harbor. They ended up getting auctioned off because they were way overpriced. They are now worth more than ever, but then the amenities and neighborhood around it have changed dramatically for the better.
So really your mileage will vary.
In the next 2 years the foreclosure auctions and buyouts of blocks of new unsold condos by hedge/vulture equity firms will cause you most of your "pain" as they are going to buy below 50 cents on the dollar.
More than likely they will go down for the next 2-3 years and stagnate for a long time.
Most people rent out condo's rather than sell them when the market slows because they are really easier to rent and maintain vs. a single family home.
Hopefully you'll muddle along and keep up with inflation. It is DC proper so it will not be as bad as Germantown but it will take a while to make out on the positive from a pure cash standpoint that the spreadsheet is all about.
Till then, enjoy life and forget about the price for a few years, it will go up eventually just don't expect a windfall to get your 20% down payment for another place for a long time.
Hey Kevin,
Found you via Calculated Risk. Cool spreadsheet. I'm not sure that I agree with the treatment of inflation however. With tons of extra inventory, I'm not sure that inflation will apply to housing - and maybe not to rental, either. Still, just having all the Case-Shiller info broken out and machine readable is great. Thanks for all the work.
I live in one of the burbs outside of Baltimore. IMO the assumption that rents will rise 11.3% to partially contribute to the P/R correction is wrong.
Unsold housing turned into rentals will help push rents in the area down. My rent for next year will be ~15% LOWER than I'm paying this year. During the housing boom, rents rose at a pretty fast pace too. In the Baltimore-DC corridor, IMO they will drop as home prices continue to fall.
While doing random checks, I found asking prices on housing for sale around here ranged from 30% to over 150% above the state's assessed value. If the 39% projected correction is from current asking prices, I would say that figure is low. If it's from state assessed values, then it's probably realistic.
Unless something accelerates the pace of decline, the bottom probably won't be reached until 2010 to maybe 2012. Then, add another 10 years or more after it bottotms to get back at or near purchase price. This is a natural correction very similar to the early 90's except this time the bursting housing and credit bubbles are magnitudes larger. We're in real danger of falling into a severe recession or depression. I wouldn't be surprised if most of the large financial institutions are currently insolvent with all the shady off-balance sheet stuff that has gone on. We're talking Enron-type funny accounting not just by one company but system-wide.
Thanks for the info, I also came here from Calculated Risk.
A couple of things about New Orleans that I think kind of skew its data vis a vis other places.
The homeowners insurance rates here have increased several magnitudes. Whereas the insurance used to cost $1500 per year it is now around $3,000 to $5,000.
Meanwhile rents are coming down. Supply of SFH and rental units is increasing daily as people rehab houses. I feel that the supply will outstrip demand for some time. Many people are rehabing houses even though they do not plan to live in them. They are probably going to rent them so I feel that the info is skewed.
People that keep their houses they had pre-Katrina have the old insurance rates so that also skews the market and makes it cheaper to rent a house that someone had pre-storm than to buy that same house. Many market distortions = up is down kind of world.
If you are looking at New Orleans buyer beware! Lots of pitfalls, on the other hand prices are starting to come down but not anywhere near the inflation adjusted price that I believe these places are worth which is $145 per square foot. Before the storm they were at around $200 per square foot. Nicely renovated places were sometimes higher.
Great spreadsheet!
After adjusting for what I think inflation will actually be (5-6%), it looks like Phoenix renters will be in a much worse position, even after housing prices are eroded by inflation.
Thanks Uncle Ben! I always wanted stagflation to make my dream of homeownership harder to realize.
Wow. A hat tip from CR.
Welcome to the bigtime guys. Keep up the great work.
G'day Kevin -
Very nice piece of work for which I thank you very much indeed. It seems particularly valuable to anyone thinking of buying or selling in one of the 54 metropolitan areas tabulated in the lookup. But it's of lesser value if you're thinking of buying/selling somewhere else; as it stands, you've got to guesstimate which metropolitan area is most similar to the place you have in mind.
It would be an easy matter to allow for another location by adding a blank line to the lookup table. This would allow a user to enter customized values for their specific location of concern. (And, FWIW, this is also true re: many of the comments here in that if you don't agree with any of the spreadsheet's built-in values -- whether assumed or derived from data -- just put your own assumptions in.)
The rub for adding a blank line is how to come up with the appropriate values for a new location. Some of the numbers, like median price, current and historical rents, and therefore P/R are a matter record, probably available with a bit of digging. The really problematic piece of data (and the key element in the spreadsheet) is the 5 year projected price. I haven't seen the article but assume that they have some kind of methodology for forecasting this beyond a ouija board. A really valuable addition would be a fourth tab to calculate the 5 year projected price for a different location based on this or a similar methodology.
I amm struggling to figure out how the numbers in the "lookups" tab were arrived at?
I haven't read the article - BUT- the numbers for Orlando seem crazy. The June 2007 price of 552,000 for Orlando doesn't represent anything close to the average or median home price in Orlando which is closer to 300k.
A 552,000 price in Orlando puts you in the top 10% of home prices. And the number of homes priced near 552,000 that are for rent would be near zero in the Orlando area.
Can you please explain anything regarding how the article arrived at the June 2007 price for each market?
I found my way here via Calculated Risk, loaded the spreadsheet and read the Miami calculations with terror. Naturally, I think first of my own situation and am wondering what to do! The question I have is about the rental amount, they seemed low to me, I don't think rents in Miami are that low even in a low income neighborhood.
In our neck of the woods in Seattle, homes are still selling for a modest $350-360k. Roughly a half dozen of my nearest neighbors (of 110 homes in our plateau) are renters who currently pay $1500-$1600. That's fairly normal in greater Seattle to pay $500+/- per bedroom depending on location and amenities.
But your table indicates these homes rent for ~$760, half of their real rents. In fact, the last time I rented was a home on Queen Anne (a desirable neighborhood, and beautiful home) with only two bedrooms, for which I paid $1900/mo. That was in 1997-1999. I haven't seen anything other than a one bedroom apartment in a bedroom community rent for less than $800/mo in my entire adult life.
Considering that rents in our area have not increased substantially since 2000 or so, I sincerely doubt that rents will decline. These facts make me wonder about the validity of data sets such as this and their usefulness in predicting future value. No doubt, Seattle is going to have its share of housing woes. But if everybody elses data is a skewed as this, then it makes me feel much more confident that what we are really looking at is much more isolated, and far less threatening than it has generally been made to appear.
I haven't looked at the spreadsheet, but the description suggests it is a reversion-to-mean methodology.
In order for the mean to remain the mean, reversion has to actually go below the mean and stay there for a while, so your downside estimates are too "conservative".
Scary thought.
Rentals available in Seattle proper for under $800.
http://seattle.craigslist.org/search/apa/see?query=&minAsk=min&maxAsk=800&bedrooms=
Great work! It really shows how overpriced many of the markets are.
My only comment is that the 15 year average for price-rent (PR) ratio varies from a low in Pittsburgh at 10.6 and a high in East Bay at 31.6. It would seem to me that over the long term, this degree of discrepancy can not be sustained. The number is not written in stone, and has to be somewhat variable based on supply/demand, population/housing growth, etc.
In looking at the 6 lowest PR ratios - Pittsburgh, Detroit, New York, Philadelphia, Baltimore, Oklahoma City. Five of them make perfect sense, markets with high rates of homeownership, not a lot of inmigration (or population growth), and an adequate supply of units to be rented. New York, however, doesn't really meet any of those assumptions (especially 1 and 3).
I haven't read the article in Fortune (I'm going to pick it up on the way home), but I would be very interested in knowing the theories or empirical data that supports the unchangeability of metropolitan specific PR ratios.
I would also like to know other readers' thoughts on this.
The arguments for rents not increasing are convincing, but I wonder what happens when people who lose their homes to foreclosure become renters. Wouldn't that support rents increasing? Or is oversupply really that huge? I'm waiting to buy but have also been hit with 5% rent increase.
I did some research regarding the price-rent ratio and found from a Fed of San Francisco study a couple of years ago this finding:
"The majority of the movement of the price-rent ratio comes from future returns, not rental growth rates. This will not comfort everyone, as it implies that price-rent ratios change because prices are expected to change in the future, and seemingly out of proportion to changes in rental values."
That makes perfect sense. I have also heard from a very credible (someone who owns a lot of rental properties) source that to get a 6% rate return on your investment, one needs to figure that costs associated with managing/upkeep of the property also run about 6%.
In other words, one needs to plan for a 12% return to make 6% after costs. So for a $100,000 property, it should rent for $12,000 a year. Over time with no property appreciation, one can expect to make about 6% return a year. This seems about right.
If the recent historical average return of the stock market is about 8% a year, the price-rent ratios for all markets are too high.
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