Wednesday, March 30, 2016

Housing: Part 131 - The Shiller Real Home Price Index in the Two Americas (Updated)

A while back, when I first started thinking through the implications of the localized supply constraints that now are at the center of my story, I posted this graph of the Shiller Real Home Price Index.  Dr. Shiller discounts that index with CPI inflation.  The idea, I believe, is that over the long term, rent inflation should basically follow general inflation.  In theory, this makes sense.  And, empirically, it was pretty close to the truth except for some unusual rent inflation in the 1970s.  But, since Shiller has developed these tools, we have now had a 20 year period of time with persistently high rent inflation.

Now, if we are trying to decide if home prices are reasonable, it seems to me that, whatever our theory of expected rent inflation, if we have a rent inflation measure, that is the discount rate we should use on a Real Home Price Index.

So, on my first go around with this, I posted this first version of the graph, with my correction.

As you can see, this tames that scary looking monster of a graph quite a bit.  We aren't so much overpaying for homes as we are paying higher rents for them.  The difference between my graph and his graph is basically a measure of the transfer of wealth we have made to real estate owners in Closed Access cities.  About 1/3 of the value of our residential real estate was just a winning lottery ticket for people who happened to own property in places where policy makers became more dysfunctional during their tenure.

But, even my version had a sizable hump in 2005.

Now that I tend to think of these things more locally, it occurred to me that this measure really should be local.  A few cities have Case-Shiller home price indexes and CPI Owner Equivalent Rent measures that go back at least far enough to capture the housing boom period.

Here, I have added three cities to the graph: San Francisco, Dallas, and Atlanta.

For 3/4 of the country, irrational or unsustainable prices should not, and never should have been, part what buyers are concerned about if they are deciding to buy a home.  It is simply not relevant.  Dallas and Atlanta and a hundred other cities have never even remotely moved out of the long term range of home prices.  There is nothing to see here.

And, San Francisco isn't hitting the top of the chart because of irrational buyers.  It's hitting the top of the chart because there is no end in sight to its dysfunctional housing market.  Rents will keep rising until it is fixed.  The reason a buyer has to pay so much for a home in San Francisco today is because they have to assume that rents 10 or 15 years from now will be double what they are today.  The market failure would be a market where Price/Rent in San Francisco was not any higher than in Dallas.

Buyers in San Francisco aren't banking on the irrationality of the housing market.  They are banking on the irrationality of San Francisco housing policy.  They really have no choice.  The San Francisco Board of Supervisors forces real estate owners there to be wild speculators on the autocratic tendencies of the San Francisco electorate.  The Supervisors really have no choice either.  You get elected in San Francisco for referring to those beautiful, easy Dallas and Atlanta price trends as "trickle down economics".  In San Francisco, you get elected by showing concern for high rents, not for solving them.  75% of the country knows how to avoid rising rents.  It must not be that difficult.  It's just not how to get elected in San Francisco.

Meanwhile, Robert Shiller, the great economist who has made these wonderful tools available to us, has spent the last 15 years warning people in Dallas and Atlanta about bubbles.  And people post pictures of his scary blue line to explain how out of control markets are.

PS:  By the way, do you notice that really long period of stability in home prices before the 1970s?  Do you think we got that through macroprudential management?  Through tight controls on home building?
No.  We got it by building and lending.  There was consistent growth in mortgages as the New Deal housing policies were implemented.  California was growing by 3-5% per year, and real private fixed investment was growing by 5-7% per year.  You want stability?  Let's try that again.  (Ironically, lenient lending and building policies would lead to declining mortgage levels because real estate values would fall.  Open access is the sustainable policy regime.)


  1. Great post. As baseball season is nearly upon us, I will say, "You have hit it out of the park!"

  2. Atlanta still experienced a massive foreclosure episode, as people still could not afford the houses but by easy money loans that failed.

  3. The idea, I believe, is that over the long term, rent inflation should basically follow general inflation. DLF park place