Housing Bubble Wonkery

HOUSING BUBBLE WONKERY….In my housing bubble post this morning, I mocked the idea that the bubble would end in a “soft landing” and rashly predicted that home prices in Southern California would drop 10-20% over the next two years. A few commenters suggested that (a) a 10-20% drop would be a soft landing and (b) a 40% drop might be more likely.

As to the first, you can decide for yourself what constitutes soft and what constitutes hard. A 20% drop seems pretty hard if you’re the one trying to sell a house, but it probably seems soft if you’re figuring its effect on the overall economy. Eye of the beholder and all that. As for the second, though, here’s what my prediction is based on. It’s a wildly simplistic analysis, but hey ? this is a blog! If I can’t be simplistic here, where can I be?

Take a look at the chart on the right. The dark blue line shows the actual median price of new and resold homes in Southern California since 1988. Prices peaked in 1991, then dropped, and then started shooting upward again in 1996.

Now, where would home prices be if they had increased steadily since that time instead of booming and busting? If you assume a “natural” rate of growth of 5% per year, the median price today would be about $360,000. If you assume a 6% growth rate, the median price would be $430,000.

The actual median price today is $492,000. So how much is that overvalued? If you assume that houses “should” appreciate at 5% per year, prices are 36% higher than they should be. If you assume 6% per year, prices are 15% higher than they should be.

My guess, based on the record of long-term historical growth, is that the 6% number is closer to the truth. Thus, even after the skyrocketing growth of the past few years, houses in Southern California aren’t that overpriced. I’d be surprised if prices dropped from their peak more than 20% ? though of course, if someone lobs a nuke at Abqaiq and oil prices go to $300 a barrel, all bets are off. On the other hand, if the bubble bursting of the early 90s is any indication, it might be four years before prices start to rise again, not two. We’ll see.

POSTSCRIPT: Needless to say, there are much more sophisticated ways of estimating the “true” value of housing, including comparisons with rental prices, number of homes bought as speculation, and so forth. This is just the one that seems to make sense to me. Take it with a great big shaker of salt.