Wednesday, April 1, 2009

Real Estate Fundamentals.

I cut my teeth as a housing analyst at Kidder Peabody after graduating from Wharton in 1972. I learned that the health of the housing markets is dependent on six key factors:
1. the level of interest rates;
2. the employment setting;
3. the economic setting;
4. demographics (population growth and household formations);
5. affordability; and
6. the relationship of the cost of home ownership to renting.
With public policy targeted at lowering mortgage rates and stabilizing the jobs market and economy (seen by late 2009 or early 2010), a better backdrop for housing is in sight, but what most observers are missing is the current massive improvement in affordability and a major tilt in favor of home ownership over renting.
As seen by the two metrics below, affordability has dramatically improved:
1. Median existing and new home prices divided by median incomes are now at 2000 levels.
2. Median home prices to disposable income (admittedly skewed by higher net worth individuals) is now at 40-year lows.
If the cost of owning a home is no different than renting a home, then the tax, psychic benefits of ownership, and so forth will result in an improving demand component for housing.
Such is the case today.
Setting the Case-Shiller Home Ownership Cost Index to the Owners Equivalent Rent in 2000 to 1.0 times yields the following conclusions:
  • The cost of home ownership in March 2009 is only 13% higher than the cost of renting a home. This ratio compares to a 73% higher cost of home ownership vs. renting at housing's cyclical peak in 2006.
  • If we take out the high ownership cost/rental cost cities of Miami, New York City and Washington, D.C., then the national cost of home ownership is now equivalent to renting.
No doubt, a vigorous recovery in housing awaits improving consumer confidence and stability in the employment and economic picture. These conditions are all dependent on the degree to which policies gain economic traction in the last half of 2009.
Nevertheless, the improvement in affordability and the benefit of home ownership over renting holds even more significance over the near term.

No comments: