Response to John at ArizonaRealEstate Notebook

John Wake - Real Estate // Mar 22, 2008 at 8:10 am

http://www.arizonarealestatenotebook.com

Well, I did not see prices going up they way they did in the first six months of 2005 and I didn’t see prices increasing for 12 months after the sales top in July 2005.

Inertia is the most powerful force in nature. Prices could be below their “market” value but that is more difficult than going above their market value.

I see a lot of pent up demand for homes. Once the conventional wisdom is the prices have bottomed out, sales will improve significantly. Many buyer don’t have to see good prospects for appreciation. They just need to see no prospects for depreciation.

However, as fast as prices are falling now, inertia could overshoot the market (you say $160K is the market but I think that is much too low. $180 is too low in my ballpark estimate). In the case of an overshoot, there would likely be appreciation again quickly, within a year or two.

Brian McMorris // Mar 22, 2008 at 11:23 am

John, I agree with your basic ideas about inertia. But your conclusion that $180K is an overshoot is flawed by most rational metrics.

I think Dr. Robert Shiller has shown conclusively (rationally) in studies of real estate values over 200 years of data, that real estate appreciates from 0 to 1% annually “REAL” return (that is, after inflation is netted out). This is logical. I don’t think real estate can appreciate faster than an economy in the longest run (that is productivity growth plus inflation).

If inflation is averaging around 4% the past five years and going forward a couple more years, then the appreciation rate should be around 5% from a normalized level (4+1). I think we can argue that January 2003 was a somewhat “normal” market for real estate nationally, as well as AZ.

If we look at your graph, the average home was at around $140K on Jan 1, 2003. If we compound that value at 5% over six years, we come up with a “normal” value of $187K on Jan 1, 2009. But, like you, I think inertia is powerful and trends tend to overshoot the normal. This is why I think $160K is a reasonable bottom valuation. Time will tell.

10 Brian McMorris // Mar 22, 2008 at 11:41 am

One more thought: there are some fundamental factors that can change these purely technical trends, in which case, inertia / slope of the trend could change almost instantly:

1. The Congress legislates some action to put a “floor” in on home values. This is possible in this crazy election year. There is some talk about a big tax credit (like 10% of price towards down payment) for home buyers. That would probably do it.

2. The global Central Banks and other big institutional money sources (Saudis?) drive mortgage rates down to 4% for fixed 30 year to rescue the housing market.

3. The Fed government buys up foreclosed houses and auctions them off to the lowest bidders or back to the original owners (kind of a dream scenario for the Socialists among us who want government to take care of us)

4. The last possibility is the dooms-day scenario where the Feds can’t save the big banks from failing, all mortgage lending stops, and home prices fall through to the basement becaue there are no buyers. This is the 30s Great Depression scenario, but I think the Feds and Congress have the ability to stop this from happening (at least I hope!)