Tuesday, January 27, 2009

Misconception 1 – One housing market

I spent 5 years writing a thesis on speculative forces in residential housing markets and will do a series of blogs on misconception and reality in the US housing markets.

The mainstream media and politicians often talks about the housing market as if it’s one single market. While for some purposes there is a grain of truth in this, for most purposes this is downright misleading.

Let's start by thinking about what a "market" is. A market is made up of goods that are reasonably close substitutes for one another. However while houses are similar in some ways (they all have walls, roofs, provide shelter etc) houses in one city/region are not generally substitutes for those in another city/region and often even within a particular city it can be more useful to think of a lot of loosely connected separate markets than one market. This range of local markets is primarily due to three things: location, housing type and housing quality.

Location - If I’m looking for a house in New York a house in LA isn’t much good to me no matter how much the price falls.
Type - If I’m looking for suburban house for myself, my wife, three kids and a dog a condo probably isn’t for me.
Quality – if I can afford a house in the price range $175-200K a house worth $500 K isn’t relevant to me.

What we see at the moment is a some similarity among housing markets across the US (i.e. prices are generally going down) and then significant differences between cities/regions and even within cities/regions between housing types and housing quality.

Looking at house price by city/region. Those that went up the most generally coming down the most. For example, prices in LA and Miami boomed around 175% between 2000 and mid 2006 and are now down nearly 40% from their peak while in cities like Denver, Charlotte and Dallas prices only rose 25-40% during that same period and have only come down 5-10%. For detailed data http://www2.standardandpoors.com/portal/site/sp/en/us/page.topic/indices_csmahp/0,0,0,0,0,0,0,0,0,1,1,0,0,0,0,0.html It appears houses prices are steadily coming back to historically "normal" levels compared to incomes and rents. So probably some considerable way to fall in the boom cities.

Even within the same city/region there are wide discrepancies in how properties in different price ranges (quality) or type are selling. While reliable statistics for these are harder to come by (due to small sample sizes) the real estate agents and buyers and sellers on the ground are well aware of this.

Brett Steenbarger looks at months of housing inventory/sales for three different price ranges in the city he lives in (Naperville, IL). http://traderfeed.blogspot.com/2009/01/more-evidence-of-lumpiness-in-housing.html He concludes “There is little inventory problem at the lower end of the housing spectrum; speculation in that market had centered on the luxury end, where there is more than 3 years of inventory…. In my looks at other suburban communities, from Washington to Florida, I have seen similar lumpiness in inventory.”

Here Brett looks at a wider view across both cities and housing types
Again, there is huge variation across different types of housing in the same city and also obviously between cities.

For a more comprehensive view based on the Case Shiller housing market indices see:
They show that prices changes for different types of houses (condo's versus single family homes) and price levels (i.e. quality) have varied significantly. Again markets

There are a large number of investors on housing market blogs who are saying “all markets are local” and they are right. However they area also saying “my market is fine”. Obviously for some of them this is the case but given the state of most markets this is probably more the exception than the rule.

At the same time politicians and their advisers are in the midst of a trying out and planning a wide range of actions to stabilise "the housing market". If these policies are based on the idea of a single market they are bound to have some very unsatisfactory and unwanted results.

In the case of both investors and politicians it appears that self delusion is a powerful force.


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