Shadowstats CPI and the Housing Bubble

[jimmygu3]

Re: Shadowstats CPI and the Housing Bubble

To summarize further -- the price of housing has remained constant relative to inflation in all sectors, but real wages have tended to follow the rate of P/C price changes. The ability of people to pay for homes has thus declined. Either way the price of homes became progressively higher than the incomes of those purchasing them, which makes it a bubble.

Well put, Kurt! Welcome to iTulip!

[goldy675]

Re: Shadowstats CPI and the Housing Bubble

Okay, for now i'm not going to dive into the hall of mirrors of the FIRE vs P/C economies, and i'm going to exlore the much more easily digested income vs. real estate price analysis.

I think you need to include the original values for housing and income in the calculation, not just the % change.

Let's set both housing and income at a baseline of 100, for ease of calculations:

After the increases, housing is at 228, and income is at 155.

155/228=.68 (rounding)

1-.68=.32, thus a 32% difference in 2005 housing prices vs income as compared to 1990.

I agree that the change in house price per change in income implies that housing is currently 32% overvalued relative to its 1990 value. However, that is neglecting the quite important interest rate factor.

Mortgage rates in 1990 were in the neighborhood of 9.5%, according to http://www.mortgage-x.com/x/indexes.asp

And they dropped down to around 5.7% in 2005.

For simplicity, i'll substitute in some sample numbers:

Assume that in 1990, a house would be purchased for $100000 at a mortgage rate of 9.5%

A $155000 house purchased in 2005 with 9.5% apr 30 yr mortgage would have the same monthly cost per income ratio, right? Such a house would have a monthly mortgage payment of 1303 according to my quick mortgage calculator.

However, in 2005 it seems that same house would actually cost $228000, and would likely be purchased with a 5.7% apr 30 yr mortgage. This house would have a monthly mortgage payment of 1323.

(1323-1303)/1323 => 0.0151... which implies that this house is now approximately 1.5% overvalued, relative to the monthly payment cost in 1990.

So, according to this calculation, it seems that there is no obvious bubble in housing. That doesn't sound very appealing to me, especially since i'm not currently a home owner.

[Andreuccio]

Re: Shadowstats CPI and the Housing Bubble

I agree that the change in house price per change in income implies that housing is currently 32% overvalued relative to its 1990 value. However, that is neglecting the quite important interest rate factor.

Good point. When friends would ask me if it was a good time to buy because interest rates were down, I'd say you're better off buying when rates are high but prices are down. Then you can refi or sell when rates drop and prices rise. It doesn't work the other way around.

Mortgage rates in 1990 were in the neighborhood of 9.5%, according to http://www.mortgage-x.com/x/indexes.asp

And they dropped down to around 5.7% in 2005.

For simplicity, i'll substitute in some sample numbers:

Assume that in 1990, a house would be purchased for $100000 at a mortgage rate of 9.5%

A $155000 house purchased in 2005 with 9.5% apr 30 yr mortgage would have the same monthly cost per income ratio, right? Such a house would have a monthly mortgage payment of 1303 according to my quick mortgage calculator.

However, in 2005 it seems that same house would actually cost $228000, and would likely be purchased with a 5.7% apr 30 yr mortgage. This house would have a monthly mortgage payment of 1323.

(1323-1303)/1323 => 0.0151... which implies that this house is now approximately 1.5% overvalued, relative to the monthly payment cost in 1990.

Did you see Charles McKay's excellent graph here:

http://www.itulip.com/forums/showthr...16792#poststop

comparing the price of housing to the price of gold? Apparently, housing, (at least in Seattle), peaked relative to gold not in 2005, but in 2001.

Looking at prices relative to payment is also interesting in terms of using CAP rates to value rental properties. (http://www.itulip.com/forums/showthr...16124#poststop) Does it matter what the price of a property is relative to rental income, or is mortgage payment compared to income what we should really be interested in?

So, according to this calculation, it seems that there is no obvious bubble in housing. That doesn't sound very appealing to me, especially since i'm not currently a home owner.

No, you're fine. Just wait until interest rates rise and prices drop, then buy and refi on the next cycle. Or wait until 100 oz gold will buy you your dream house.

[EJ]

Re: Shadowstats CPI and the Housing Bubble

Eric,

Wow, thanks for the detailed reply! I am always humbled and challenged by the experts like yourself in the iTulip community who take the time to answer questions and break things down so that those of us without a PhD in Econ can digest it all.

Good point that the FIRE chiefs don't want inflation to turn the tables, allowing mortgage-holders to repay with cheap dollars. Just refi me into a 100-year neg-am mortgage, set me up with a third job on the overnight shift and I'll be fine.

Jimmy

Thanks for the question. Always glad to answer good questions from our paid-up subscribers, to borrow a James Grant phrase.

[whitetower]

Re: Shadowstats CPI and the Housing Bubble

Too bad Big Paul Volcker isn't Fed Chair -- I'd die to have seen a 200 basis point increase in the Fed rates last month.

[Charles Mackay]

Re: Shadowstats CPI and the Housing Bubble

Eric,

Wow, thanks for the detailed reply! I am always humbled and challenged by the experts like yourself in the iTulip community who take the time to answer questions and break things down so that those of us without a PhD in Econ can digest it all.

Good point that the FIRE chiefs don't want inflation to turn the tables, allowing mortgage-holders to repay with cheap dollars. Just refi me into a 100-year neg-am mortgage, set me up with a third job on the overnight shift and I'll be fine.

Jimmy

Jimmy, you don't have to look any further than the tripling of the gold price and the halving of the US dollar to find tacit evidence that inflation is far higher than published statistics.

But, re: your question, houses aren't tangibles anymore... they are paper (mortgage paper, sub-prime paper, etc.). My friend who moved to Mendoza just bought a 75 acre orchard with 3000 sq ft. house w/ guesthouse for $240,000. But, there is no mortgages available. You have to pay cash because of the currency collapse there. That is going to happen here in the U.S. too.

[jimmygu3]

Re: Shadowstats CPI and the Housing Bubble

Jimmy, you don't have to look any further than the tripling of the gold price and the halving of the US dollar to find tacit evidence that inflation is far higher than published statistics.

But, re: your question, houses aren't tangibles anymore... they are paper (mortgage paper, sub-prime paper, etc.). My friend who moved to Mendoza just bought a 75 acre orchard with 3000 sq ft. house w/ guesthouse for $240,000. But, there is no mortgages available. You have to pay cash because of the currency collapse there. That is going to happen here in the U.S. too.

Charles,

While a lack of available mortgages would put a big damper on prices, a declining currency would have a positive effect on nominal prices, in local currency. Would you happen to know if Mendoza real estate has gone up or down in nominal local currency terms? Just curious.

Jimmy

[Charles Mackay]

Re: Shadowstats CPI and the Housing Bubble

Charles,

While a lack of available mortgages would put a big damper on prices, a declining currency would have a positive effect on nominal prices, in local currency. Would you happen to know if Mendoza real estate has gone up or down in nominal local currency terms? Just curious.

Jimmy

If you are young and have no money, but you do have a good job and steady earning power, then I could see gambling on shorting the dollar via taking out a mortgage (paying it off in increasingly worthless dollars). That may actually be the only play that you have? Basically you have nothing to lose other than your credit rating. But just make sure you can survive the periodic manufactured deflations. Your house will lose 2/3 of it's value in terms of gold, oil, and commodities but it's true you may still make some nominal dollar gains.

If you have money, you are better off putting the assets into a "hoarding" asset. Gold is in the first few innings of a historic bull market (having to reach $2200 just to get back to it's 1980 valuation) so it's one of the cheapest assets in relative value out there.

[jimmygu3]

Re: Shadowstats CPI and the Housing Bubble

I wasn't being facetious- I really am curious about nominal prices in Mendoza if you have any data.

It just occurred to me that a person who owns a house outright would be concerned almost solely with real values, while one who puts "zero down" is concerned almost solely with nominal prices. Everyone in between is a mixture of the two.