« Censoring Climate Scientists | Main | Walling Iraq » Price-Rental Index11 Dec 2007 11:45 am
Paul Krugman points to a revealing chart courtesy of Barry Ritholtz. Some of this is low interest rates making homeownership legitimately cheaper than the price of the house as such would indicate, but there's clearly something way out of line here. Speaking of real estate, it's always good to see advertisers coming up with innovative new names for neighborhoods. 11th and V is apparently "Logan North" now. Comments (15)
ah, i get it housing prices to average rent . . . sorry about that. 
Can someone explain this chart to me? What is the y-axis?
I like that you are using more charts, but as the veiwers above mentioned, the charts often don't have the minimum (both axies labled, for instance, something they have been stressing in my daughter's 3rd grad class) for them to be understood. I want to see what you are saying. I'm interested, but I think you need to work on this. If the charts aren't labled, give a text explaination, although the standard for a good chart is it is immediatly self explainitory.
Uh, yeah, what cw said. I want to understand this chart, but I don't.
some seriously lazy commenters around here. if you click on the link you'd find this explanation of the y-axis: "Ratio of OFHEO house price index to personal consumption expenditures on rent"
Ratio of OFHEO house price index to personal consumption expenditures on rent Um, thanks, I saw that, too. Take a moment to help the slow children, please. What is the "house price index?" The average monthly mortgage payment of all home owners, against the average payment of all renters? Are they tied to equivalent property values? (i.e. does this tell us that the rent v buy question has changed per property -- that the relative cost of renting is up? Or just among averaged groups?) Seriously, is it that hard to say in English what is this chart describing? X used to be twice Y, but is almost now 3.5 times Y. What, exactly, are X and Y?
This is not entirely specific to housing, however. In general discount rates appear to have become lower, which is just another way of saying that current asset prices have become relatively high when compared to expected future income streams. There is a lot of speculation about why that is happening, but one possible explanation is a global reduction in economic uncertainty caused by things like better monetary policy, improved supply chain management, and so on.
to help out a little: OFHEO (office of housing enterprise oversight) has a house price index that (i don't recall the precise methodology, but basically) looks at price changes in existing homes to calculate an index as to the cost of housing. The BLS, as part of constructing the CPI, treats home ownership as a capital investment and instead, for cost-of-living purposes, looks at what renter's pay (and then calculates an owner's-equivalent-rent, which is to say what would you pay for your house if you were renting it, not owning it). Because your choices to put a roof over your head are either to buy or rent (excluding the homeless and squatters), it's reasonable in economic terms to look at the ratio between them to get some sense of what is "normal." (of course, people buy homes for reasons other than that it's a "better deal" than renting, but still, from an economist's perspective, homo economicus is making that choice.) so what we have here is evidence that over a 25-year period, there was a fairly constant relationship between the cost of buying a home and the cost of renting a home, and then, around 2000, the ratio between the cost of buying a home and the cost of renting a home (annualized, i'm pretty sure) exploded. as they say on wall street, the most dangerous words in the english language are "this time it's different," so the odds are that as the housing bubble unwinds, we are going to see the ratio revert to its historic norms. This can happen in one of 3 ways: a.) housing prices can tank; b.) rents can rise; c.) some combination thereof. none of us is smart enough to know which of those 3 will play out, but we can, by looking at this chart, have a pretty good idea that one of those three will.... a more technical discussion of all of this can be found here: http://www.frbsf.org/publications/economics/letter/2004/el2004-27.html
DTM, you raise a good point: a prolonged period of low inflation, improved capital flows, better hedging instruments, and a corresponding reduction in risk premiums has led to a pricing up of assets because of a higher present value of future cash flows. as we are seeing, the reduction in risk premiums got a little carried away, shall we say, and that's why a housing bubble is leading to credit market freeze-ups as risk premiums begin to be restored and heavily leveraged positions are exposed....
OK, from Krugman's NYT site in an update he clarifies the chart for people like me who didn't understand it (my PhD is in chemistry, not economics): Update 2: For readers who are confused by the chart, it’s roughly speaking the ratio of the price of an average home to what it would cost to rent a similar home for a year. “roughly” because for technical reasons (both are index numbers) it doesn’t literally tell you that houses cost 25 years’ rent; you have to judge the ratio by historical norms, not on the absolute number.
OK, for those of you who tried to help us liberal arts majors but still didn't close the deal. Is it correct that this chart's take-home lesson is basically that in 2000 it cost @ 2.25 more times to own a house than it did to rent; since 2006 it now costs @ 3.25 times more to own than rent?
howard, And the big question appears to be whether we are likely to repeat the historic mean valuations in the future, or whether instead there has been a structural break such that the future mean valuations will not be the same as the historic mean valuations. I personally think the evidence for a structural break is pretty good, but only time will tell.
Structural break in popular urban areas, though currently to some degree inflated by speculators, would be my expert opinion (who had no idea what that chart said until the chart experts explained it to me).
fnook: ome seriously lazy commenters around here. if you click on the link you'd find this explanation of the y-axis: "Ratio of OFHEO house price index to personal consumption expenditures on rent No, that would actually be some seriously lazy graph makers. It's not the reader's responsibility to go track down the information needed to understand the graph. The graph should be self explanatory. How freakin' hard is it to label your damn graphs, anyway? This is my biggest pet peeve with graphs.
Comments closed December 25, 2007. |
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Heads in the Sand
The y-axis range is from 20 to 35 . . . which will tend to exaggerate the "way out of line"-ness of the variation. Also, "homeownership legitimately cheaper than the price of a house as such indicate" . . . what does that have to do with a price-rental index?
Posted by southpaw | December 11, 2007 12:02 PM