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Sunday, August 03, 2008

Housing: Buy Now or Wait?

by Calculated Risk on 8/03/2008 02:09:00 PM

Peter Hong at the LA Times asks: Should you buy a home now?

A few quotes and comments:

The main argument against buying a home now is that values are still spiraling downward. Stay on the sidelines and you'll be able to buy that dream home for a much lower price than now -- about 25% less in Los Angeles County, predicts Celia Chen, director of housing economics for Moody's

Chen bases that guess on several factors, including the high inventory of unsold homes and the gap between current prices and income.
In general this is probably correct. In many of the bubble areas - like Los Angeles County - prices will probably continue to fall for some time. The question of how much further prices will fall depends on several factors (even in the bubble areas): homes at the low price end, in communities with high foreclosure rates and strong household growth, are probably closer to the price bottom than mid to high prices areas where foreclosures are just starting to increase.

In some of these low end areas, REOs are already selling at 60% or more off the price peak, and in these few areas, it might actually be cheaper to buy than to rent. Of course there are probably very few readers interested in buying in these areas, except possibly as a rental property investment.
Los Angeles economist Christopher Thornberg believes that home prices will stabilize when homes are affordable to about 25% of the adult population. For that to happen in Southern California, home prices would have to come down 20% to 35% from their current levels, Thornberg said.

"There's no way in hell the house you buy now will be more expensive next year," he said.
In general, I agree with Dr. Thornberg - even in the few areas where prices are close to the eventual nominal bottom, there is no reason to expect that prices will increase over the next year.
Margaret Smith, a Claremont financial planner and former university economist ... say[s] that a home is almost always a smart investment, even if values do temporarily decline.

Smith and her husband, Gary Smith, a Pomona College economist, say buying is practically a sure bet when you would pay less for a monthly mortgage and other home costs than what it would cost to rent the home.

They call that monthly savings the "home dividend" and say it will offset a short-term decline in a home's value. The monthly rent savings not only is money in your pocket but also can be invested elsewhere.
Sounds good, but remember that the Smiths wrote a paper in 2006 called: Bubble, Bubble, Where’s the Housing Bubble?. Here is an excerpt from that paper:
We show how to estimate the fundamental value of a house and use unique rent and price data for matched single-family homes in ten metropolitan areas to illustrate this approach. These data indicate that the current housing bubble is not, in fact, a bubble in most of these cities in that, under a variety of plausible assumptions, buying a house at current market prices still appears to be an attractive long-term investment.
House prices have declined about 30% in Los Angeles since the Smiths' paper was published.

Hong concludes with some sound advice: Don't buy expecting appreciation, and don't buy if you are planning on moving soon. The question "buy now or wait?" depends on the circumstances and desires of the potential buyer - so there is no general answer.

In general, I expect house prices to continue to fall for some time, especially in real terms (inflation adjusted), and especially in the bubble areas. Historically, most significant housing price busts lasted 5 to 7 years from peak to trough, and with record inventory, tight lending standards, high price-to-rent, and high price-to-income ratios, I see no reason yet to expect that this price bust will be any shorter.