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Robert Shiller: Fundamentals No, Psychology Yes

For those of you that are interested in more lengthy reading, a new paper by Robert Shiller (as in Case-Shiller) was released this weekend: Understanding Recent Trends in House Prices and Home Ownership (pdf).

Here are a couple of money quotes:

It does not appear possible to explain the boom in terms of fundamentals such as rents or construction costs. A psychological theory, that represents the boom as taking place because of a feedback mechanism or social epidemic that encourages a view of housing as an important investment opportunity, fits the evidence better.

Within the United States, the current boom differs from prior booms in that it is much more of a national, rather than regional, event.

Here’s a great chart that summarizes the foolishness of any argument that home prices are supported by “fundamentals”:

Home Prices vs Rent vs Construction Costs

Enjoy.

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About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market. Tim also hosts the weekly improv comedy sci-fi podcast Dispatches from the Multiverse.

18 comments:

  1. 1
    AndyMiami says:

    There are several papers from prominent economists from last week’s Bernanke’s Jackson Hole retreat (must be nice) that are available in various bubble sites. Shiller’s paper is a bit heavy on psychology and underscores the credit bubble created by low interest rates and exotic unregulated financing. Also he mentions that London had a similar fall in prices that we are seeing nationally today from 2004 Q2 to 2005Q2, and then the upward move continued. He does state that this can happen in the US during the current down cycle…We will see and I do not think anyone can predict what will happen, but he does conclude that 50% declines are possible. Lastly, he puts SEATTLE in the same category as LA, SF, San Diego…as one of the bubble centers..

  2. 2
    Garth says:

    The only mention of seattle in the 41 page PDF is as follows:

    The boom showed its first beginnings in 1998 with real (inflation-corrected) home
    price increases first exceeding ten percent in a year on the west coast, in the glamour
    cities San Diego, Los Angeles, San Francisco and Seattle.

  3. 3
    AndyMiami says:

    Exactly. Seattle is not mentioned in the cities that were non bubble cities like Dallas, Charlotte (these cities will also see declines, but less than 15%)..The Seattle main media has on many occasions stated that Seattle is not part of the bubble..these monkeys just do not realize that Seattle is behind the curve.. and no matter how great the local economy is doing, in a way, Shiller’s PSYCHOLOGY is what Seattle’s bubble heads may prove Shiller to be correct…

  4. 4
    jimmycrackcorn says:

    “San Diego, Los Angeles, San Francisco and Seattle. ”

    That is good company..Gotta love the West Coast ….

  5. 5
    AndySeattle says:

    “the glamour
    cities San Diego, Los Angeles, San Francisco and Seattle”

    So maybe we’re not a World Class City… A Glamour City has a nice ring though.

  6. 6
    jon says:

    Certainly a lot of money shifted from the stock market to real estate following the 2001 meltdown. I think a lot of last year’s run-up in the stock market was money going back to stocks from real estate. I’d guess the money will stay in the stock market for a while until the money market stabilizes. Everyone is concerned about what will happen as the boomers start to retire in larger numbers. A lot of what happened in Southwest real-estate was caused by people jumping the gun on that retirement trend. So the slow down now may be people waiting to see what the next bandwagon will be. North Carolina is my bet.

    About that Schiller graph, he left out some things. First, the increase in average house and condo size (to make living on smaller lots tolerable). Second, as traffic around the major cities reaches congestion levels, the amount of money people are having to pay for land to keep their commute under X minutes will increase. Third, we are also continuing the trend to more urban living, especially for seniors who are wanting more convenience and luxury than before. That trend toward more expensive areas will bring up the average cost. Same thing is happening in Europe, where small towns are disappearing.

  7. 7
    NoFate says:

    Jon …dude …with all due respect:

    First, Shiller’s model is the ONLY one that compares the same homes over time, making size irrelevant.

    Second, we have buses, trains, working from home etc. Plus businesses are not stupid …they are expanding further into the suburbs.

    Third, as people retire they DOWNSIZE. After the kids move out they leave their 5 bedroom house in the burbs for a 2 bedroom condo somewhere …often somewhere warm.

    What IS obvious in the Case-Shiller Index is that we have reached a place that was created though market psychology, 1% Fed Rates and Fraudulent Mortgages (i.e. NINJA, liar loans, teaser rates, etc.). This place is called a BUBBLE.

    If you think this won’t impact Seattle then go to eLoans and try to get a loan on a $600k rental property. I checked it yesterday and they are willing to loan to someone with excellent credit if you will put down $180k and 4 points (about another $20k). For this opportunity they will charge you 8% a year APR.

    The party is over!! All that’s left is the crying… and the ride back down!

  8. 8
    NoFate says:

    Final note on the $600k mortgage …ONLY 30 year fixed is even offered and no second mortgages built into the deal.

    Anyone with a rental that has an ARM with a reset is probably screwed unless they can cut a deal with the bank. Even then, the rent probably won’t cover the mortgage making default the best option.

  9. 9
    Old Ballard says:

    “Third, as people retire they DOWNSIZE. After the kids move out they leave their 5 bedroom house in the burbs for a 2 bedroom condo somewhere …often somewhere warm”.

    If the downsize is going to work you have to sell the 5 bedroom house in the burbs in a market where the number of first time buyers is almost zero, gas will never drop below $2.50 a gallon and traffic sucks. Mom and Dad could turn it into a reatal if it’s paid off or on the downside of a 30ty, but then their stuck waiting on the rent check to come in before making the condo payment. Here’s an idea. With all the new rentals on the market shouldn’t rents drop? Whoops, maybe the rent check won’t be enough.

  10. 10
    RottedOak says:

    The idea that all or most retirees downsize is a myth. Some do, but most people retire in the home they already live in. When they do move, they typically stay near their family. That’s too bad for anyone who purchased real estate in places like FL, AZ or CA based on the idea that boomers would be flooding the place after retirement. There will be some (because, yes, some people do relocate), but most of the shifting will be intra-regional. This type of demographic trend might change the relative pricing for condos or smaller homes vs. McMansions, but I don’t see any reason to think it will cause a general price increase or decrease.

  11. 11
    PDX Renter says:

    too bad for anyone who purchased real estate in places like FL, AZ or CA based on the idea that boomers would be flooding the place after retirement

    Believe it or not, Portland OR believes it is a destination for retiring boomers. While I think the seniors like the idea of living in someplace like Portland, actually living there is quite a different thing. I don’t know too many olds who enjoy damp, gloomy, cold 9 months out of the year. So while some will inevitably move here, I beleive most will leave after a couple of winters.

  12. 12
    biliruben says:

    Despite my pleading, my ma (retired boomer) bought an over-priced townhome in SE Portland.

    To make matters worse, she kept her old house and is renting it out. Ugh.

    6 months ago:

    “Hey Ma, why don’t you sell your place and rent downtown to see if you like it?” The market’s about to collapse and it would be a great time to sell.”

    “Great idea, son! I’ll do it!”

    3 months ago:

    “Geez. Getting this house ready to sell is a pain. Renting is for losers. Maybe I’ll just take a peak at the housing market…”

    1 month ago:

    “I bought a townhouse with obviously problems in it’s contruction, son. But ain’t it a beaut! You have to come for Christmas!”

    “I’ve also decided it’s too much work to sell. I’ll just rent it to my deadbeat ex-boyfriend instead. I’m sure he’ll pay the rent on time, and fix it up nice! So what if he never lifted a finger the last 5 years in the place.”

    Why are you moaning son?”

  13. 13
    Angie says:

    I don’t know too many olds who enjoy damp, gloomy, cold 9 months out of the year. So while some will inevitably move here, I beleive most will leave after a couple of winters.

    Eh. Winters in Portland are far kinder to old people (young people, too, for that matter) than anyplace snowy and icy.

    My inlaws are in their mid-70s and “retired in place” in the greater Portland area. They’re going strong and still happy to be there.

  14. 14
    Chris says:

    Talk of retiring in damp, gloomy places, has anyone noticed the massive development and boomer influx on Whidbey Island in the last 3 years? It’s unbelievable. And price appreciation? Out of this world, worse than Seattle has been.

    My parents will be moving there into grandma’s house in about three years. The weather there will be an upgrade for them since they now live in Alaska.

  15. 15

    BABY BOOMER BUST

    Here’s an interesting article from the Boston Globe that equally applies to Seattle. It basically documents a huge glut of Baby Boomers Homes on the chopping block and no qualified buyers:

    http://www.boston.com/realestate/luxuryliving/articles/2007/03/25/the_real_estate_generation_gap/?page=full

    I know, we’ll bring in more workers and they’ll buy ’em? Wrong, dead wrong. Even if the new workers replaced the Baby Boomers when they retired this Generation X can’t afford the price escalation the last 10 years. I know, we give ’em Jumbo Loans, tried that already, its bankrupting America.

  16. 16
    capt haddock says:

    for all the talk about shiller’s graphs and seattle, would someone be kind enough to inform the debate with a 1940 – today real price graph of seattle housing?!? and a price:rent graph to match?!? please!!! shiller’s national historical graph seems completely out of whack with what i have seen here. all this endless babble about bubbles in seattle is nice, but SHOW ME THE NUMBERS!

  17. 17
    biliruben says:

    You’ll have to talk to NAR and the NWMLS. If anyone has those numbers, they do, and they keep them pretty close to the vest.

    You might infer something by the lack of sharing, however.

  18. 18
    jon says:

    NoFate said: “First, Shiller’s model is the ONLY one that compares the same homes over time, making size irrelevant.”

    – Thanks, didn’t know that.

    “Second, we have buses, trains, working from home etc. Plus businesses are not stupid …they are expanding further into the suburbs.”

    Tell that to the people in Issaquah who are driving into Seattle. Microsoft is moving jobs into Bellevue and Seattle. They’re also adding buses to carry people out of Seattle to Redmond because young people want to live downtown, so that’s where companies want to be.

    On a humorous note, I don’t know how many have seen this persons take on the real estate market:

    http://www.careerbuilder.com/monk-e-mail/Default.aspx?mid=22960571&cbRecursi

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