Spotting Bubbles After They Burst
I’ve lived through two housing bubbles since I was old enough to know and care about them. During the first one I was writing quite unpopular reports for developers and lenders (I’m still not very popular with realtors) that indicated, to me at least, that the “effective demand” for housing in many areas just would not support a viable project (based on the fundamental underlying determinants of the demand for housing – population, employment, and income growth as well as new household formations). I did not understand then nor do I do now, how an industry (home building) can survive when so many decisions it makes are made with a view toward the immediate past (what sold last week or month and at what price). Of course everybody, including me, recognizes a bubble after it has burst. But there really is no substitute for understanding the fundamental underlying demand for housing in a region or community when making a decision about building or buying housing. Few have the patience or knowledge to assess the “effective demand” (the willingness AND ability to purchase) for housing versus the desire to purchase based on the current sentiment about the housing market. Potential home buyers are not likely to get that understanding from a real estate industry that can make money from a purchase regardless of whether the purchase increases in value or not. It is easy to see the “effective demand” for housing and the real conditions of the market after the fact, as with the many charts I see that show how the relationship between home prices and household incomes in a region was widening prior to the last housing market crash. Its a great way to make a call after the game is over. Household income data is reported with a lag of more than a year for smaller areas, is subject to a significant margin of error, and may likely be revised sometime down the road.
There really is no substitute for understanding the fundamentals but a quick and easy way to get a sense of where the home buying market is, is to look at the ratio of the monthly cost of purchasing a home (at the average selling price) versus the monthly cost of an average rental. Both selling and rental price data is readily available in NH from, among other sources, the NH Housing Finance Authority which regularly does rental price surveys. The chart below shows the ratio for NH going back to 1990. The ratios can be calculated for sub-areas of the state and for communities as well. The ratio is not a substitute for a thorough analysis of “effective” or fundamental underlying demand that all home builders should undertake, but for home buyers, it clearly shows that when the ratio gets above 130% or 140% (which can be determined with a data lag of only a few months at most) a bubble is likely forming.
This entry was posted on October 25, 2012 at 12:49 pm and is filed under Demographics, Homeownership, House Prices, Housing, NH Economy, Recession. You can subscribe via RSS 2.0 feed to this post's comments.comment below, or link to this permanent URL from your own site.