Hey, I don’t make the news, I just report it.
You think there’s too many real estate agents? No, there’s too many economists. How else do you explain the constant and steady barrage of studies coming out from economists about the state of the housing market?
To this list you can now add The Smiths.
These guys (er, Guy and girl? Guy and woman?) say that housing is CHEAP. (Huh?)
In a paper the two presented at the Brookings Institution this week, “Bubble, Bubble, Where’s the Housing Bubble?” they said that even though prices had risen rapidly and some buyers unrealistically expected the trend to continue, “the bubble is not, in fact, a bubble in most of these areas.”
They argued that the value of a home is determined by the rent it could fetch. Calculate the future rents, subtract mortgage payments, taxes and other costs, factor in a good annual rate of return of 6 percent or more, and one should be looking at the proper price of a house or condo.
Their bottom line was: “Buying a house at current market prices still appears to be an attractive long-term investment.”
Using the price-to-rent ratio is not new; it’s been used before, but The Smiths took it to the next level (keep in mind they did their analysis using single-family homes, not condos, and while they use “Boston” as one of their sample cities, they don’t specify exactly what area this includes – single-family homes in Boston run the gamut in size and price).
The problem is that there has not been a good way to compare rents with homes. Indexes that try often end up comparing apartment rent with prices of a single-family home. A result, the Smiths said, is inflated price-to-rent ratios that are displayed as evidence of a bubble when one may not exist.
The Smiths solution was to look for “matched pairs” of similar houses, one rented, one owned, but both in the same neighborhood. They did this in 10 cities in which they could find enough real estate data and matched pairs. Once they had established what rent was for a certain house, they used software they created to compute the flow of rents over time, factoring in the outflow of mortgage payments, maintenance costs and taxes. Then they had to determine what those future payments would be worth today, which economists call the net present value. If the net present value is a positive number, the house is worth the price. If the result is a negative number, the buyer would be better off renting it.
Their method of analysis, if not its conclusions, has been praised by other economists, including, (surprisingly?) Robert J Shuller (“I think the paper is a sign of the times”) and Karl E Case (“absolutely the correct way to think about it”).
So, what about Boston condos? Are they overpriced?
I ran out of energy. Someone else do the calculations, and get back to me.
I’m guessing, no, they aren’t overpriced.
Source and more information: Some New Math on Homes – By Damon Darlin, The New York Times
Calculating What to Pay for a Home – By Damon Darlin, The New York Times