Why House Prices are Double Dipping

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Welcome back to the sour economy.

It didn’t take long after the Memorial Day break to get the latest signs that the recovery remains in the gutter. The housing market has been looking like it was headed for a double dip for some time. On Tuesday, we got confirmation that it happened. According to the S&P/Case-Shilller housing index, home prices hit a new low since the beginning of the bust in the first quarter of the year. According to Case-Shiller, houses now cost about what they did in 2002, erasing much of the gains of the 2000s housing boom. In the past year alone, residential real estate has fallen 5%, and prices have now dropped nearly a third from their peak five years ago.

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In more bad economic news, the mood among consumers fell in May as well. One of the most commonly watched measures of confidence dropped to a six-month low, on inflation worries and fears that the slow jobs recovery would end.

People have been predicting that housing prices would rebound for a while. Most of those predictions have to do with affordability. Home prices have fallen by a third since the top of the bubble. Incomes, though, on average, have risen slightly. And interest rates have come way down. That’s made buying a house more affordable than it has been in decades. Yet, housing prices continue to fall. Why would that be?

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One answer: Rental prices. Housing affordability measures have a blind spot. They look at the cost of buying a house now versus what it has been in the past. They don’t look at the affordability of buying a house versus the alternative, which is renting. And this economy has been so bad, and empty houses have been so available, that rental prices have continued to fall.

So while buying a home is more affordable that it has been in decades, in a lot of large American cities, despite the housing price drop, renting is still more affordable. Moody’s Analytics puts together something they call the rental ratio. Here’s the list (via the NYT’s Economix blog). The rental ratio is computed by dividing the average price of a house by the annual cost of renting. When the figure falls below 17, the monthly cost of a mortgage, taxes and maintenance is less expensive than that of signing a lease. The striking thing about this data is the number of cities in which it is still more affordable to rent than own. For example, despite the housing bust, it’s still 65% more expensive to own than it is to have a landlord in San Francisco. In Seattle, Austin, Nashville and Raleigh, N.C., the purchase premium remains above 20%. Yes, it is now cheaper to buy then it is to rent in Philadelphia, but that was always the case. In general, the cities that have always been cheaper to buy have become even more so. Few cities have crossed the boundary, and in the places that have, like Miami and Las Vegas, the housing markets are so depressed that it’s hard to believe, despite the affordability, that values are going to come back soon. So people put off buying.

What’s more, many economists are predicting that interest rates will soon rise. If that happens, higher borrowing costs could again tip the scales back toward renting in some of the cities where buying has become the cheaper option.  The bottom line: It’s more evidence that the housing recovery is not coming any time soon.

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