On Smart Money.com today, Lisa Scherzer spoke with Todd Sinai about the state of the housing market and similarities between San Francisco real estate and growth stocks in Don't Buy the Bubble Talk. It's an interesting take on the Bubble theory.
Sinai says home buyers should look at the annual cost of owning a house, not its price, when considering a purchase. And based on a recent study he did with Chris Mayer of Columbia Business School and Charles Himmelberg of the Federal Reserve Bank of New York, Sinai says homeownership costs are near the long-term average, relative to rents and incomes.
How does he figure? Traditional measures of housing values, such as the rate of appreciation, or the house-price-to-rent ratio, are misleading, Sinai says.
The study by Sinai and his colleagues examined 46 housing markets from 1980 to 2004, estimating the true one-year cost of owning a house and comparing it to rental costs and income levels. Naturally, the low interest rates of recent years have offset high prices by keeping mortgage payments down. Variable and interest-rate-only mortgages have also lowered the annual dues of homeownership.
That's why the most expensive U.S. markets are especially sensitive to changes in interest rates. In any city, the faster prices appreciate, the more they'll drop if mortgage rates rise. "The so-called bubble markets really are more sensitive to changes in interest rates, because they are markets where people are buying the right to live there in future years," says Sinai.
And to make sense of the high prices in San Francisco he continues with the growth stock analogy
Another thing that's been going on, another way you get a low annual cost of housing is if you expect the market to have high capital gains, high future price growth. You'd expect the price of rent to go up. If you have a higher expected capital gain, that total annual cost will be lower. What markets are like that? In San Francisco, over the last 60 years, real annual house price growth was 3.5% per year. The national average is about 1.5%. There are a handful of other places like that: San Diego, New York City, Boston... If you compound that over 60 years, it's huge... In markets like San Francisco, people should be willing to pay a higher initial price [for a house] because they expect to get more of the value back on paper.
As an analogy, San Francisco is like a growth stock because more of the value comes in the future. Whereas Philadelphia is like a value stock: The value is not going to go much higher.
So, the bubble is not really about prices getting to high for it's britches, but the rising cost of ownership, which involves financing. The forecast for mortgage interest rates is to rise slowly over the next year. A general slow down is expected, but because of our persistent inventory shortages, home prices are likely to continue to rise above historic norms.
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