Saturday, September 20, 2014

A Sustainable Housing Recovery?

NEW HAVEN – Volatility in the housing market has long been known, but until now it has never been visible in so many places around the world at the same time. Indeed, the year 2009 might even be a milestone marking a new era of volatility.

Since 2000, we have seen the most dramatic evidence ever of speculative bubbles in markets for owner-occupied homes. Home prices exploded after 2000 in North America, Europe, and Asia, and in many isolated places elsewhere in the world. Markets peaked in 2007, and then fell sharply in many of these places with the onset of the global financial crisis. Surprisingly, prices rebounded in some places in 2009. It seems the story never ends.

In the United States, the S&P/Case-Shiller 10-City Home Price Index recorded the biggest turnaround since the index began in 1987, rising 5% (a 15% annual rate) from April to August 2009, after having fallen 7% (a 21% annual rate) in the four months from December 2008 to March 2009. Recent increases in home prices have also been seen in Australia, the United Kingdom, Hong Kong, Korea, Singapore, and Sweden, and optimistic talk is heard in still more places.

Housing prices are on a rollercoaster ride, and we may never be able to make complete sense of their movements, other than to understand the volatility that they represent. Indeed, in a volatile speculative market, where people buy and sell in anticipation of further price movements, history confirms that price movements will be hard to explain, even after the fact. They reflect changing investor psychology, which is hard to discern, and new information, which may still be amorphous and ambiguous.

This surge in volatility appears to reflect a new and different attitude toward homes as an asset – an attitude that has spread around much of the world. We used to think that homes were in the same category as automobiles: depreciating assets that grow obsolete over time, are costly to maintain, and go out of style, eventually to be scrapped and replaced. Now we think of them as claims on increasingly scarce resources in a rapidly growing world, with prices potentially skyrocketing any day.

It used to be commonly thought that a home’s value consists primarily in the structure, not in the land on which it sits. This should be increasingly true as high-rise condominiums become more common. In some cases 100 homes can, in effect, be stacked on one another. With such intensive use of land, our land constraints for housing construction are vanishingly small. This long-term trend towards multifamily housing may be expected to continue, further diminishing the importance of land to home values.

But the recent speculative bubbles have in effect boosted the percentage of land value in home value. Although much of this was temporary, we now tend to think of homes as land rather than structures. Economists usually compute urban land value by subtracting the estimated construction cost of the home from the home price, so that land value is inferred as a residual. Economists do this because in most places direct sales of vacant urban land are rare, and often involve unusual places or unusual circumstances, that make such sales unrepresentative of land values underneath homes. Thus, the bubble component in home prices is attributed to a surge in land prices, even though land prices outside of bubbly urban areas are vastly lower.

Many people appear to believe that upswings in home prices reflect increasing scarcity of land in a world constrained by rapid economic growth and severe resource constraints (symbolized by the fear of global warming). They view the recent collapse of the housing bubble as merely the effect of a temporary financial crisis, which governments around the world seem to be confronting aggressively.

Such thinking may be playing a part in the recent rebound of home prices. But in fact, it is probably more accurate to think of the ups and downs of the world’s housing markets as a reflection of the change in our thinking about housing as an investment.

If so, the volatility in home prices after 2000 was the result of faulty thinking, not of the natural effects of global economic growth, which has occurred at a relatively smooth rate for decades now. Faulty thinking, in turn, encouraged loose practices by mortgage lenders, and led central banks to take no action against housing bubbles as they developed.

In many countries, governments in 2009 responded to the collapse of housing bubbles by instituting policies aimed at supporting these speculative markets. The result, however, has been to lead people to add another, political, component to their assessment of home prices, unhinging them further from economic fundamentals.

A basic fact is often forgotten: the modern construction industry is quite capable of building vast numbers of fine modern homes, including units in high-rise buildings, at costs far below the prices of homes in many urban areas today. This should put a break on long-run escalation of home prices.

Housing speculators seem often to be betting on the political equilibrium that restricts the supply of housing, and on the indefinite continuation of the artificial supports started during this financial crisis. But, in a newly global economy, with increasing interregional and international population flows and widespread commitment to economic freedom, it is very hard for governments to restrict supply in the long run.

That is why it appears safer to predict high volatility in 2010 than to predict that home prices will rise.

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