September 26, 2023

Economix: Is Another Housing Crash Coming?

Mark Zandi, chief economist at Moody's Analytics.Mark Zandi, chief economist at Moody’s Analytics.

Looking at the relative prices of buying and renting homes in Silicon Valley, Manhattan and a few other places is enough to make you wonder whether parts of the housing market are still due for a crash. To consider that question in more detail, I had a conversation with Mark Zandi, the chief economist at Moody’s Analytics, which provided much of the data for my column:

Q. I’m struck at how much higher the rent ratio still is in many places, relative to its average from 1990 to 2010. It’s about 18 in Washington (relative to a 1990-2010 average of 13), about 17 in Boston (relative to 15) and 15 across all metropolitan areas (relative to 11). Is there any reason to think the ratio should remain higher in the future than it was in the not-too-distant past? Or should we expect the ratio to continue falling in coming years, either through further house-price declines or through rent increases?

Mr. Zandi: I expect the house-price-to-rent ratio to continue falling at least through the remainder of this year and next. National house prices are set to decline by 5 percent this year, and apartment rents are on track to rise by about 5 percent. I do expect house prices to stabilize in 2012, but rents will continue to rise strongly.

Supporting the strong rent growth is declining apartment vacancy rates. Apartment demand is healthy given the better job market and accelerating household formation, particularly among younger households that generally rent, and the ongoing foreclosure crisis which is forcing families from home ownership into renting. Apartment construction is also especially low by historical standards. If this script roughly holds, the house-price-to-rent ratio will be back close to its long-run average in most areas of the country by 2013.

Q. What about the Bay Area? The ratio is still an astronomical 35 in the East Bay, 31 in San Jose and 27 in San Francisco. Given what the national housing market has been through in the past several years, how are we supposed to believe that Northern California is not suffering from a major housing bubble right now?

Mr. Zandi: No, I don’t think the Bay Area of California is currently suffering a housing bubble, despite the region’s still historically high house-price-to-rent ratios. Supporting the region’s higher price-to-rent ratio is mounting demand from overseas investors given the region’s very significant global economic links. The rapid growth of Asian economies over the past 20 years, with strong links to the Bay Area’s economy via international trade, immigration and investment, is especially important.

Californians have also been conditioned to buy homes during housing busts. The California housing market has been through many ups and downs, and if history is any guide, people who buy on the downs are rewarded in the long run. The Bay Area housing market is very supply-constrained, which means that house prices rise quickly once housing demand picks up even a little bit.

Having said this, I wouldn’t be surprised in Bay Area house prices take longer to rev up than in times past given the current very debilitating housing crash, allowing rents to catch up, at least partially.

Q. When we were talking earlier, you mentioned that a straight comparison of rents and prices argues for renting in most places — but that once you consider other factors, the issue becomes a closer call. Can you explain what you meant?

Mr. Zandi: A literal interpretation of the current house-price-to-rent ratio argues that it is still better for most households to rent rather than buy. This suggests that a prospective home buyer might want to wait until house prices fall even more before buying, but there are several important things to consider.

Most of the coming house price declines will be for distressed properties — foreclosures and short sales. In fact, prices for nondistressed homes are holding up well and may very well have hit bottom. And timing the precise bottom of house prices is an intrepid affair, and may not the best strategy if the homeowner plans to live in their home for more than a couple of years, as most homeowners do.

It is also important to keep in mind that mortgage rates are extraordinarily low, with the rate on a 30-year fixed rate mortgage currently well below 5 percent. Rates could go lower, but it is unlikely. As the economy continues to gain traction and the Federal Reserve ends its zero interest rate policy, mortgage rates will move higher. Indeed, in a well-functioning economy fixed mortgage rates will be closer to 6 percent.

The still high price-to-rent ratio means that home buyers shouldn’t be in a rush to buy a home, but owning is quickly looking more attractive, and it won’t be long before owning is once again more financially attractive than renting.

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