Infoporn for the Real Estate Data Junkie

by Alex Stenback on February 22, 2008

The 2007 Residential Real Estate Activity Report, from the Minneapolis Area Association of Realtors:

Mark it, dude. 2007 will go down as one of the most interesting years in the history of residential real estate.
                               – Jeff Allen, MAAR Research Manager

Though 2007 can definitely be characterized as an interesting year, our feeling is that by the end of 2008, we’ll be looking back at 2007 as a pretty good year, relatively speaking.  Here’s why:

It’s all about supply right now.  There is simply too much, and too much to come, and with some estimates showing upwards of 35% of existing for-sale inventory in some stage of foreclosure, we find it hard to imagine the market achieving anything resembling price stability in 2008.

Also worth noting, if you haven’t the stamina to wade through the entire report, is that despite the swoon we’ve seen since 2006, total appreciation since 2001 has still been fairly robust.  Though some may take that as another sign that we have further to fall, these figures are only slightly higher than the historical average annual appreciation rate of 5-6%.


{ 7 comments… read them below or add one }

Nate February 22, 2008 at 11:15 am

Alex, 5-6% annual appreciation actually seems a bit high. Historical data, excluding the last 6 years or so, supports a number closer to 3-4%, essentially inflation +1% or so. Logically this makes sense, what drives housing appreciation is people having more money. As their wages increase home prices tend to rise, when their wages don’t increase (such as during a recession) home prices tend to stagnate or even decline.

What is interesting about the last 6-7 years is that they immediately followed the increase in prices that occurred from 1995-2000.

As you can see from this report, Minnesota actually did very well during this period, experiencing a yearly average appreciation of 6.2%, one of the higher averages for the nation incidentally. During this time period, average real wages were going up, and there was a major influx of people moving into Minnesota supporting such an increase.

Traditionally following this period of expansion, there would have been a slower period with little or no appreciation. Numerous average housing price charts show this trend that goes back decades. It’s these slower periods that pull average appreciation back into range of normal inflation. In terms of our recent history this would have correlated with the economy slowing at the end of the Tech bubble. Housing would likely have cooled for a number of years until the economy picked back up. Instead we have had houses continuing to appreciate for another 5-6 years in addition to the 6 years from the late 90s.

In an attempt to keep the economy going, various events conspired to make money much cheaper to lend around 2001-2002. This kept the economy going, resulting in the housing market enjoying another 5-6 years of above average appreciation. Notice that during this time real average wages stagnated for most workers, instead of wages this economic expansion was driven by cheap credit. As a result we saw the savings rate for the average American plummet as they acquired much more debt, either on credit cards or through home refinancing.

The result in housing was that, at least locally, the real price of homes increased substantially as wages didn’t keep up. Page 35 of this report has a good graph specific to Minneapolis.

Notice that in 2000-2001 we were approaching the higher average point for our market, which correlates to the price appreciation from the late 90s. It’s after that point that things got a bit out of control.

We have now entered the period that will correct for the recent years of excess. We see the results every day in higher foreclosures and defaults, tighter lending standards and massive inventories. These will all continue to pressure housing prices.

I don’t have a crystal ball, so I can’t say with any certainty where prices will end up. However, statistical analysis of historic data tends to teach us that historic norms exist for a reason. Housing prices have traditionally had a correlation to rents and wages. People were only willing to pay a certain premium over rent to own a home. Rent prices are dictated by prevailing wages in a region.

In recent years people have been willing to pay a higher premium to own a home due to viewing their home as an investment. This will have to continue for prices to be maintained. It is interesting to remember that in the late 90s people were also willing to pay significant premiums for internet and other tech stocks. That is no longer the case.

Nate February 22, 2008 at 11:17 am

Hmm, the second URL I reference for the charts is incorrect. Here is the correct URL.

Alex/Editor February 22, 2008 at 12:23 pm

As always, great additional insight and data from Nate, who is on the money here.

Nate February 22, 2008 at 2:53 pm

Yeah I wasn’t trying to argue with you, but I have specific concerns related to expected appreciation for homes. You’re 5-6% number is much better than others I’ve seen proposing 8-10% yearly appreciation as normal. It’s hard to get a historical average after a we’ve experienced a significant increase, the same problem existed on stocks early into the bubble correction.

Why I think it’s important is that it greatly effects price discovery for the housing market. Expecting 6%+ a year in appreciation from a home alters the decisions made by sellers. After 10+ years in such a market, it’s going to take considerable time for people to adjust.

People certainly value properties much more than they have historically, and thus have been willing to pay a significant premium over rent. The best recent example is the numerous people choosing to rent out properties at a loss rather than attempt to sell at current prices. This type of behavior is very much based on a belief that significant appreciation will return relatively soon. Without the hope of significant appreciation monthly losses on top of maintenance costs quickly erase any chances of profit.

From a business sense, it is hard to justify such an action. Classic rental business models show it to likely be unprofitable and eventually fail. This has certain comparisons to how tech start-ups could attract money without actually turning a profit. Smart people were more than willing to invest heavily in companies with flawed business models that never saw profit and eventually failed.

Alex/Editor February 22, 2008 at 3:22 pm

Agree with your analysis – one of the things we had not considered was the above average appreciation rates from 95-00.

An interesting extrapolation would be to take the data you cite to come up with a number we can call normal – basically 3-4% annual appreciation since 1995, then see what that delta looks like.

The PMI risk index and studies done by National City seem to suggest that we are in the ballpark of 10% overvalued, though I do think the expansion of credit, and now it’s contraction have served to amplify the curve (so to speak) and the ensuing decline that will show those studies to be a bit optimistic.

This thing will end up somewhere between the bearish view of 3% annually since the early 90′s, and 10% lower than where we are today, and it will of course vary greatly by specific area within the metro.

What is striking to me is the number of people I am starting to hear talk about prices being a “great bargain” right now. My answer to them is “just wait.”

Nate February 22, 2008 at 4:37 pm

I approached the problem from a different angle in an attempt to calculate a potential floor for housing prices.

Price discovery can be seen as people deciding what percentage of their income they want to pay for housing. Traditional advice has said no more than 30% of income should be spent on housing. Innovative mortgage products that get buyers to focus on monthly payments and rapid appreciation have easily pushed this percentage up in recent years. 40% and higher has become much more common. Individual markets vary as well.

So the question is, what will the market decide to go back to? Historically, Minneapolis did appear to be closer to 30% based on income and home values. The North East neighborhoods (St Anthony) in Minneapolis are a good example. Houses were cheap, but average incomes were also pretty low.

This PDF shows the average incomes from 2000 by neighborhood:

We have a while to wait until this data is updated by the next census. But various reports have suggested that incomes have at best kept pace with inflation. Certainly specific jobs are suffering more now, such as mortgage lending, realtors and construction. Current data may not be much improved.

Along with incomes, you have to consider debt. The average American is carrying more debt now than in 2000, and that can effect how much they can afford to spend on housing.

So it becomes a rather simple equation. What percentage of income will the market decide on (an unknown), and what are current incomes (another unknown). Then based on that, what house prices can they afford based on future market rates and mortgage products (another unknown).

If you try to apply historic norms to these numbers, it tends to make you look like a massive market bear (30% of income, unimproved average incomes, and say 7-8% traditional 30 yr mortgage). And as you’ve also said, individual markets will vary. I tend to think people are deciding on how much of an investment housing really is, and it’s going to take years to work out and arrive at an answer.

Chuck February 22, 2008 at 8:57 pm

You guys are missing the Big Picture:

Historical statistics cannot be applied to 2002-2007 since housing in these years was driven by widespread “balloon” lending and speculation, on a scale never before seen. Now that these toxic loans have been shown to be very painful to the lenders who offered them, they will not offer them again. Prices will now fall to a level that fits with traditional, amortizing, fully-underwritten lending, which is probably 2001 prices or lower, given the lack of available move-up home equity.

People may not have have much of a choice in how much of their income they will “invest” in a home, the lenders and mortgage investors will decide.

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