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Sunday, April 14, 2013

Shiller and the Upward Slope of Real House Prices

by Calculated Risk on 4/14/2013 03:06:00 PM

Professor Robert Shiller wrote in the NY Times: Why Home Prices Change (or Don’t)

Home prices look remarkably stable when corrected for inflation. Over the 100 years ending in 1990 — before the recent housing boom — real home prices rose only 0.2 percent a year, on average. The smallness of that increase seems best explained by rising productivity in construction, which offset increasing costs of land and labor.
Shiller's comment on the stability of real house prices is based on the long run price index he constructed for the second edition of his book "Irrational Exuberance".

As I've noted before, if Shiller had used some different indexes for earlier periods, his graph would have indicated an upward slope for real house prices. Here was an earlier post on this: The upward slope of Real House Prices. A few excerpts:
It is important to realize that Professor Shiller used the quarterly Case-Shiller National index starting in 1987. From 1975 through 1986 he used what is now called the FHFA index. He used other price indexes in earlier periods.
The FHFA index used by Shiller was based on a small percentage of transactions back in the '70s. If we look at the CoreLogic index instead, there is a clear upward slope to real house prices.

If Professor Shiller had used the Freddie Mac quarterly index back to 1970 (instead of the PHCPI), there would be more of an upward slope to his graph too. So it is important to understand that for earlier periods the data is probably less accurate.
The indexes I used captured a larger percentage of the market than the indexes Shiller used.

Tom Lawler has also written in depth about this: Lawler: On the upward trend in Real House Prices

During the housing bubble, the difference between a slight increase in real prices (0.2% per year according to Shiller's index) and a slightly larger increase in real prices using other indexes (probably closer to 1.5% per year) didn't make any difference; there was obviously a huge bubble in house prices. But now it makes a difference.  A key reason for the upward slope in real house prices is because some areas are land constrained, and with an increasing population, the value of land increases faster than inflation.

Shiller adds this incomplete comment:
[R]eal home prices should decline with time, except to the extent that households shell out some money and plow back some of their incomes into maintenance and improvements, because homes wear out and go out of style.
He is referring to the structure only, and he is leaving out the value of the land!

The bottom line is there is an upward slope to real house prices.