The Almost Daily 2¢ - Reflecting On Real Big Busts

Today, Eric S. Rosengren, President of the Federal Reserve Bank of Boston (FRBB) gave an excellent speech entitled “A Historical Perspective on Housing Downturns” which, with some fairly thorough detail, attempts to add some context to the current downturn by reflecting on both the prior housing boom and bust seen in New England as well as the gruesome boom and ongoing 17 year bust currently unraveling in Japan.

I strongly encourage the reading of this speech as it both makes a good presentation the basic elements of the unwinding of residential real estate as well as strongly indicating that members of the Federal Reserve are keenly aware of the potential risk.

Although, interestingly Rosengren makes a final plea that homeowners that are experiencing stress seek help at the newly established “Mortgage Relief Fund” but as I have noted before, this initiative as it is currently specified is very limited and at best could only help 500 homeowners with small mortgages and with no late payments.

For some time now I have been working on some basic analysis and predictions for overall home price declines for Massachusetts and elsewhere in the country.

Although the analysis is not quite complete, I figured that I would share what I have for Massachusetts as it ties in closely to what Rosengren has presented in his speech.

Eventually Ill fold all the charts and data into a recurring post that covers many regions and is updated monthly.

First, a word on the approach… it is basic and not at all unique or new.

Based on Professor Shiller and other notable economists study of long term “real” (i.e. inflation adjusted) home/real estate prices, I simply inflation adjusted either the OFHEO or S&P/Case-Shiller (where there was enough data) home price indices to date and then extended the consumer inflation (CPI sans shelter) and “nominal” and “real” price series data to bring the future “real” prices down in line with the historical average real annual returns seen in the last 30 years.

It’s important to note that that average annual “real” growth of home prices in the last 30 years have ranged somewhere between 1% and 3% above inflation.

It’s also important to note that although this has been the trend seen since 1970, there have been periods with similar durations where “real” growth has fallen below 1% and even turned negative and, as Professor Shiller demonstrated with his 1890 home price series, over the really long term, “real” annual growth rate of residential real estate is between 0% and 1%.

The following chart (click for much larger version) shows that in order to bring Massachusetts “real” home prices (as tracked by the OFHEO home price index for Massachusetts) in-line with the average annual return of 2.5% seen since the early 1970’s, nominal prices have to complete a 16.8% decline (or 28.8% in “real” terms) from the latest peak.

To date, prices have only come off 3.5% so more downside seems inevitable.

Note that I would have preferred to use the S&P/Case-Shiller series for Boston but that series starts in 1985 and simply doesn’t have enough data to adequately capture the long trend of average “real” appreciation.

Although the forecast I have provided shows prices declining through 2012, it’s always possible that the decline will either be slower or faster likely based on wider economic events (recession etc.) so I will continue to update this chart monthly with the latest actual data to get a sense of how the adjustment is actually occurring.

I believe that using the 2.5% average “real” rate of appreciation represents a very conservative guide as there is no evidence to suggest that this rate of appreciation can’t fall to 2.0% or even lower.

Consider for a moment that with the complete 16.8% decline, nominal home prices would simply revert back to where they stood during Q4 2003.

In a future post, I will provide data and charts showing what the decline would look like at lower long term average rates of “real” appreciation but suffice it to say that with every .5% decline to that average, nominal prices have to come off significantly.

Also, as I mentioned, I will provide the same analysis and charts for many other areas around the country but with just a cursory look, there are areas like Miami, Phoenix, and Las Vegas that look simply hideous with truly tremendous corrections in store to put those markets back in-line with their historical averages.

More to come!