February 19, 2010

Im sure that if you polled most real estate agents, youd find that the number one question asked of them is Where do you think the market is headed? or some variation on that theme.  Not wanting to pull the Ouija board out and ask the spirits for the answer, I try to answer with the best empirical data available, and then still qualify the answer with a small shrug of the shoulders.  Even the best economists missed forecasting the changes that occurred in our economy over the last 18 months, so who am I to forecast the housing market without qualifying my response.

One of the economists who actually did accurately call the correction in the housing market was Professor Robert Schiller of Yale University, best known for the Case-Schiller Home Price Index.  Another fairly accurate predictive model came out of the UCLA Anderson School. Professor Schiller is now stating that studying rents will provide a powerful indicator of where the price of housing is headed.  This is a bit challenging for Lamorinda real estate where the rental stock is relatively small when compared to larger metro areas.  Nevertheless, it might be worth looking at.  With regard to broader market trends, Schiller is suggesting the following:

• In normal markets, people wont pay a large economic premium to own vs. renting.
• Historical trend data strongly suggests that when the ownership premium greatly exceeds historic averages, a housing bubble has occurred.  This is precisely what happened during the last run-up in housing prices.
• In the converse, an indicator that housing prices have normalized will occur when the ownership premium returns to historical levels for a given area.
• Deutsche Banks REIT research team found that in 1999 (prior to the real estate price run-up), Americans were willing to pay a 13% premium to own vs. renting an equivalent home.  This analysis took into consideration all of the obvious tax implications of ownership.  By mid-2006, Americans were spending an average 66% premium to own!  That was the peak of the bubble.
• The present picture varies widely across the US in some areas it is now cheaper to own than rent (Riverside & San Bernardino counties), and in a 14 area metro study that included San Jose, the ownership premium is 6% or less.
• In aggregate, the analysis suggests that prices have another 5% adjustment ahead in order to be in line with 1999 levels perhaps a bit more since rents still appear to be in slight decline.

So what does this all mean for our local market?  We are probably at or near the bottom.  Since the only way well know that weve reached the bottom is when we are on the way up and looking back, Im still shrugging my shoulders a bit when I get the Which way is the market headed? question asked of me.  As a former business professor of mine at Berkeley once told our class, If you take all of the economists in the world and line them up, theyll probably all be pointing in different directions.  I guess that leaves us to figure out the general direction of their index finger.