Their paper is here:
http://morris.marginalq.com/DLM_fullpaper.pdf
This is a careful analysis, and implies that house prices need to fall a lot for the real PE ratio to return to historical norms (the long run norm seems to be about 5 percent, and we are currently around 3.5 percent--turned around, the PE ratio has risen from about 20 to a little under 30).
A couple of issues worth considering, though. First, land use regulation is surely more binding now than it was 20 years ago, meaning higher expected long-term growth rates in prices may not be unreasonable. Using their benchmark analysis, expectations about growth need to be 1.5-2 percent higher now than they were in the past in order to get equilibrium. This is certainly possible, if not likely.
Second, owner occupied housing has improved in a variety of characteristics not measured in the decennial census. Most important, AHS data show owner-occupied housing is getting relatively larger in terms of square footage. The data reported in the census (number of rooms) is not as reliable an indicator of quality as living area. Vintage will to some degree pick this up, but the omission of living area from the census creates an important problem. One could say the same thing about building materials and finishes.
That said, the paper is well worth reading--and should leave us a little more frightened than we were before.
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8 comments:
"Most important, AHS data show owner-occupied housing is getting relatively larger in terms of square footage. The data reported in the census (number of rooms) is not as reliable an indicator of quality as living area."
Clearly true, but not necessarily relevant if you assume (no reason not to) that there is a declining marginal value to sqftage per capita, which will especially be true if the size of the plot is constant.
You received a mention in the wall street journal blogs today for your comments on this study:
http://blogs.wsj.com/economics/2008/01/02/houses-rents-and-bubbles/?mod=homeblogmod_economicsblog
Why would land use regulations increase the price of owned homes but not rented ones?
"Why would land use regulations increase the price of owned homes but not rented ones?" Yeah, that's what I'm wondering, too. And also to Richard's point about the quality (i.e., sq ft) of owner-occupied housing being on the increase, I would assume (absent data to the contrary) that the owner/renter proportion of new construction is the same as the proportion of old construction.
Richard: I did a back of the envelope P/E ratio study for the Washington DC area and it was posted on Bubble Meter Blog by David. Here is a link:
http://bubblemeter.blogspot.com/2006/02/real-estate-pe-ratio-for-washington-dc.html
I would love to hear your thoughts about it. I guess it is time to update it and see what is happening now!
Eric in DC
This blog was really good I liked it a lot. The link brought out all details regarding Rent-to-Price ratio for housing, which I was eager to know.
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