Yale University Professor Robert J. Shiller, newly minted Nobel laureate and cofounder of the Case-Shiller indices, has voiced a word of caution for the country’s current housing market trends. Shiller believes that some locations like San Francisco and Las Vegas are showing what he describes as “bubbly” behavior, or indicators of possible bubbles. While he doesn’t think these places and other notable hotspots are in bubbles right now, he says the makings are there. One thing that leaves him to doubt their development in the current market is the attitudes of the people currently buying homes, and that they don’t seem to expect much appreciation, which could have a stabilizing effect when prices start to moderate. For more on this continue reading the following article from TheStreet.
Yale University Professor Robert J. Shiller has just won the 2013 Nobel Prize in Economic Sciences for his work on asset prices, along with Eugene Fama and Lars peter Hansen.
Shiller’s study of how stocks and bonds are priced found that in the short-term markets are not always efficient and do not necessarily reflect fundamentals, because market participants are often irrational.
For those who closely follow the housing market, Shiller is a well-known name. He developed the widely followed S&P/Case-Shiller Indices that track home prices, along with Karl Case.
His book Irrational Exuberance in 2000 warned that the stock market was in a bubble, surrounding activity in the dot-coms. The 2005 edition of the book spoke about the bubble in real estate.
So if you haven’t been paying attention to his views on housing, you might want to sit up and take notice now.
In recent months, Shiller has warned that some regions are looking "bubbly", referring to the dramatic annual price gains in cities such as Las Vegas and San Francisco.
But overall, he does not believe we are in a bubble..yet.
"Home prices right now are just reasonable. They are where they have been for a century in real terms. They are not high or low. They are OK," he said in a Bloomberg Television interview last week.
Home buyers do not appear to be displaying a bubble mentality either. Shiller just recently conducted a survey of recent homebuyers.
The short-term expectations were somewhat high, with respondents saying they anticipated a 5.7% increase, on average, in the next year. But in the bubble years of 2004, buyers projected an even higher 8.7% increase.
Moreover, buyers longterm expectations appear quite modest at 4.2% a year for the next 10 years. At that rate, if consumer inflation is modest at 2% a year, we wouldn’t return to the December 2005 peak in real prices until 2031.
According to Shiller, people seem to be buying homes now because they think it is a good time to buy, with the economy gradually pulling out of a recession. They aren’t buying because of expectations of a boom in housing, which is typical of bubble behavior.
So all this is good news. But you won’t get that impression listening to Shiller. He still comes across sounding bearish, sending mixed signals.
That’s because after years of studying home prices, the Nobel Prize winner believes that housing is a risky investment that does not really compensate investors for the risk over the long term.
According to him, data going back to 1900 shows that the return of home prices in real terms, meaning once it is adjusted for inflation, is "about zero."
Buyers tend to think home prices will always appreciate because land is scarce and therefore has value. But as he points out in the Bloomberg interview, land prices are in most places only 20% to 30% of home prices. It is expensive only in some places.
Secondly, there has been technological progress in building. It has become more efficient, offsetting the increases in land prices.
And three, buyers still prefer new buildings over existing ones. Old homes sell at a discount to new homes so that offsets the increase in land prices.
This is how Shiller and Case effectively defined a bubble in a Brookings Institution Paper in 2003. "A tendency to view housing as an investment is a defining characteristic of a housing bubble."
So if we are not in a bubble yet, how do we know when we are in one? Shiller provided a checklist a couple of years ago, according to a DealBook report. .
- Sharp increases in the price of an asset like real estate or dot-com shares
- Great public excitement about said increases
- An accompanying media frenzy
- Stories of people earning a lot of money, causing envy among people who aren’t
- Growing interest in the asset class among the general public
- "New era" theories to justify unprecedented price increases
- A decline in lending standards
This article was republished with permission from TheStreet.