 |
|
 |
|
 |
|
 |
|||||||||||||||||||||
|
In my opinion, real estate is getting more credit than it deserves. The pundits believe that the appreciation of owner-occupied homes kept consumer spending strong during the recession. The argument is that during 2000, home-price growth alone added close to $2 trillion in wealth to the U.S. household balance sheet. However, stock-market losses during this period amount to approximately twice the gain in home equity. If the net of the two is to have a positive effect on consumer demand one has to be prepared to argue that the marginal propensity to spend out of household wealth is more than twice the marginal propensity to spend out of stock wealth. But to most of us, a dollar worth of wealth is a dollar. It does not matter where it comes from. During the recent market meltdown, home prices kept rising and consumer spending was strong. Earlier in the decade the opposite was true. The wealth in residential real estate as a percent of disposable income declined through most of the first half of the '90s while real GDP grew at a below-average rate. During the late '70 and early '80s, the rise in home wealth coincided with an economic recession, and the differences in marginal propensity did not keep the recovery from going into recession. So we need a different explanation for the real-estate boom. Temporary fluctuations in current income do not have as large of an impact on consumer spending as permanent changes to current income. The stock-market parallel here is that of the price-to-earnings ratio. During temporary decreases in current earnings, prices fall by less than the earnings and the P/E ratio rises. Similarly, during temporary declines in current income, the net-worth-to-income ratio increases much like the P/E of the previous example. If consumers, like investors, see through the temporary dip, consumer spending will remain relatively unchanged. So, here's the short of it. The recent market decline reduced household wealth. However, as one looks at the historical relationship, it is apparent that U.S. wealth is fairly high and clearly higher than it has been anytime prior to 1997. The decline in our total wealth is much less than that of the stock-market decline. That is why consumer spending has remained strong. With this in mind, here's how real estate stacks up going forward: Residential real-estate prices tend to decline in real terms during periods of economic slowdowns. Based on the historical data, you can expect a cyclical downturn in real-estate prices. Given the mildness of the recent recession there won't be a major decline in nominal home prices. The decline, if any, should be in real terms (or adjusted for inflation). The experience of the last three decades shows that periods of rising tax rates and inflation have a differential impact on real estate and the stock market. Higher taxes and higher inflation tend to lower the stock-market return both in an absolute and relative way. Since there doesn't appear to be a tax-rate hike on the horizon, nor a rise in the underlying inflation rate, the trend of the last few years should continue. Short of a major positive shock (i.e. tax reform, etc.), the rate of real-estate appreciation should be slower than that of the market. The return obtained by individual investors will depend on their leverage ratio and their tax status. The housing bears worry that if the economy makes a strong recovery in the second half of the year, rising mortgages would be sufficient to pop the housing market by deterring new buyers and increasing the debt-service burdens of existing homeowners. This is a classic case of partial equilibrium analysis. Of course, if interest rates rise, all else remianing the same, values go down. However, in life, everything else is not usually the same. One needs to ask why rates are going up. If the rate increase is due to the Fed putting on the brakes and causing a credit crunch, values will go down and so will the economy — a recession will ensue. If, on the other hand, rates rise because the economy is booming and the demand for credit is going through the roof, income will also rise and people will be able to afford their mortgage payments. As is usually the case, the bears don't look at the whole picture. Americans who want a new home are not going to be constrained by any one year's income. Americans are only constrained by their net worth. Want the real-estate boom to continue? Cut tax rates. That will work just fine.
— Victor
A. Canto and Peter Mork of La Jolla Economics |
|
|
|
|||||||||||||||||
<% dim printurl
printurl = Request.ServerVariables("URL")%>
he
American Dream is alive and well, we're being told, with the residential
real-estate market becoming the one investment area that has boomed during
and after the recession. Reading the financial press, it seems that we
ought to thank the real-estate market for saving the economy.
