Tuesday, December 29, 2009

Price Data Is Good News For Home Buyers

Wall Street Journal
Homes are now cheap.

No, not everywhere in the country (more about that later). And, even after the latest Case-Shiller data, it's anyone's guess when they might actually turn around and start rising steadily again. It could be years.

But if you've been thinking of buying a home to live in, the current meltdown is a big opportunity.

You might not know it from the coverage of the latest data. Too many, as usual, are focused on the trees instead of the forest. The 10 and 20-city composite indexes were unchanged between September and October. And the numbers were lower than a year ago, but the rate of decline seems to have slowed: Two facts that are both obvious and practically useless. Indeed the latest survey contains a whole truckload of information for all those who prefer data to knowledge.

But long-term fundamentals are more important than the short-term noise. And it's generally a mistake to pay too much attention to doomsayers or to overthink these things.

Here's some home truths.

Real estate prices in the Case-Shiller 10-city index have now fallen by a stunning 30% from their 2005 peak. Nothing like it has been seen since the Great Depression–and, according to some sources, not then either. Obviously for anyone who bought a home at the peak of the market this has been a disaster. But for those thinking of buying a home now this is exceptionally good news.

And at the same time, mortgage rates have also plummeted. In 2006 you had to pay an average of about 6.4% on a 30-year fixed loan, according to the Federal Reserve. Right now you can get deals for about 5%.

Put the two together, and it's a winning combination.

The Case-Shiller 10-city data go back to 1987. I ran the numbers comparing the index values, mortgage rates and average weekly earnings. Net conclusion: On average–an important point I'll return to shortly–buying a home now is as cheap as it was in the mid-1990s, when houses were an absolute steal.

No, the Case-Shiller data aren't perfect. The biggest complaint is that they are weighted too much towards the coasts and the big "bubble" cities like Miami, Las Vegas and Phoenix.

So I decided to run the same analyses–average prices, mortgage rates and weekly earnings–for the home price data tracked by the U.S. Census. Those numbers go back further than Case-Shiller, to 1972.

You can see the results in the two charts here.

The top chart simply compares the average home price to average weekly earnings. Yes, there has been a clear, gently rising long-term trend: Over many decades people have been choosing to spend more on housing, buying bigger and better homes. But the bubble, and subsequent collapse, still stand out clearly. By this measure, median homes nationwide today are about as cheap–when compared to earnings–as they were in the early 1990s.

Yet back then mortgage rates were around 8, 9 or even 10%.

If you buy an average home today, and take out a 30-year mortgage at 5%, the annual bill for interest and repayment of principal will come to about 19 times typical weekly earnings (If you get the $8,000 refundable tax credit too, it drops below 18 times). As you can see from the bottom chart, we haven't seen it that low since the early 1970s.

You can hear the objections. Doomsayers ask: What about these waves of mortgage resets coming in the next two years? What about all the unemployment? And the foreclosures? And so on.

These are all valid arguments for refusing to buy homes when they are expensive, or even averagely priced. But the whole point about markets is that they adjust. Prices are now cheap. They reflect this bad news, and more. If you have a stable income, and you can get a 30-year mortgage at 5% or so, and you are willing to drive a hard bargain on a home in this market, this is your time.

Over and over again, history suggests that the best investments are the ones no one wants–gold when it was $260 an ounce, Amazon.com when it fell below $10 in 2002, Hong Kong shares during the SARS "crisis" in 2003, and so on. If an investment feels comfortable, it's should make you nervous. If it makes you really nervous, that's probably good.

The biggest objection, or caveat, is one I hinted at earlier. These are average prices  - check with a realator for prices on Raleigh real estate. The variations are truly remarkable. Prices in places like Miami, Las Vegas and Phoenix have roughly halved from the highs in early 2006, according to Case-Shiller. Meanwhile in cities like New York and Boston they have fallen by a fifth or less. It's hard to argue that some of the most resilient areas are cheap. New York real estate prices are still up about 75% since the start of the decade. Maybe they have much further to fall.

But outside of these hot spots, real estate is now cheap.

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