Sunday, August 20, 2006

There Are No Soft Landings – But How Bad Will This Housing Downturn Be?

We are in the early stages of a real estate downturn. Many have claimed that this downturn will be far worse than any before because prices have increased so much. But is it really that simple?

Cycles can not be properly evaluated within in the context of short time periods. One must look to longer periods of time to establish a norm from which to evaluate recent conditions.

I have selected the period from 1970 to 2005. This period provides a long enough timeframe to include four real estate booms and three full downturns. In addition, I believe that our current economic environment from a market cycle standpoint is fairly similar to what we saw in that general time frame (post stock market boom, real estate boom, and an oil shock, unpopular expensive war, rising inflation). Of course, the differences are many as well.

Over the last 35 years nominal GDP per capita has increased eight fold. Mortgage rates are lower today than 1970 (6% vs 8%), and new houses have increased in size by about 70%. The median house size has increased by about 30%. The combined effect of these facts suggests that housing prices should have increased by about 50% more than nominal GDP per capita. This would suggest that prices today should be about 12 times what they were in 1970. However, they are now only 10 times the level of 1970. So, as expensive as housing is today, it was even more expensive relative to income in 1970. This suggests that the market stress in 1970 was greater than it is today.

Our society is significantly more affluent today compared to the past. Viewed on an inflation adjusted basis (in 2000 dollars) we see that GDP per capita has doubled since 1970. In 1970 real GDP per capita was $18,491, and by 2005 it had doubled to $37,232.

Here is a link:

Of course, this tells us nothing about the distribution of this tremendous growth in affluence. But it does shed light on why homes and other assets have appreciated so much in nominal and real terms.

The boom is over, and there are no soft landings in real estate. However, I doubt that this downturn will be much different from the average.


At September 02, 2006 8:15 AM, Blogger skytrekker said...


I agree with you, and your statements at CAL Risk- but already the cheerleaders are out saying we have a soft landing, the goldilocks economy is back, housing slowdown fears overblown etc. We are about a year past the peak- from my experience here in CT a housing bubble burst can deflate for years- I think its very premature to think everything is fine and this huge bubble will just be ok.

At September 02, 2006 11:33 AM, Anonymous Anonymous said...

it's where i miss fine line, when is it over? or do you think it has already peaked out merely looking at the figures. i still remember one of the IMF report 4months ago that housing boom will adjust slowly over 3-5 years and a downturn is highly unlikely.

At September 02, 2006 4:04 PM, Blogger zephyr said...

I think that the market peaked last summer, and will decline for several years.

The severity of the decline will vary greatly from place to place, and it will be worse for condos than for detached homes. Florida condos will be a bloodbath.

At September 02, 2006 9:14 PM, Blogger njdoc said...

Perhaps part of the problems with all these analyses is that inflation measures have been systematically undereported for about 10 years (or whenever the Boskin comission occurred) and whenever people says "inflation adjusted" I just don't believe it. There is no doubt that it is in the governments interest to undereport inflation statistics to keeps their COLAs' and other infalation indexed expenses, as well as interest rates, down. There are lies, damn lies and statistics. By changing the way inflation is measured, the government radically changed the rules of the game. No doubt in the favor of the affluent.

At September 03, 2006 8:07 PM, Anonymous Anonymous said...


glad I found you over at Calculated have a new regular



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