A report released August 6 by NLIHC and the Center for Economic and Policy Research (CEPR) provides an updated analysis of rents and home prices in 100 metropolitan areas. This report, the third in a series, finds that since the housing bubble burst two years ago, home prices are falling back into their historical relationship with rents in a growing number of housing markets. While this is likely an indication that home values have either already reached bottom or soon will in most markets, the report also cautions that in many markets, the local economy is suffering, which could put off the housing market recovery. The report concludes that in the long term, the housing market will be robust only with a strong economy in which people have the incomes to afford rents and mortgages.
The paper posits that the historical equilibrium sale price of a home is 15 times the annual rent of a nearby comparable home. Where in recent decades the ratio of median sales price to median annual rent hovered close to 15 to 1 (i.e. it took $150,000 to buy a house that would rent for roughly $10,000 per year) at the peak of the bubble in 2007, this ratio exceeded 25 to 1 in many inflated markets. The paper defines a bubble market as one in which this “price-to-earnings” ratio exceeds 18 to 1.
The original analysis of these 100 metropolitan areas was completed in April 2008. In this third paper, the authors find that 14 out of the 27 markets considered inflated in April 2008 are no longer considered to be bubbles due to the fall off in prices. The authors also analyzed the ability of new homeowners to accumulate equity in five years, and find that while first-time homebuyers in 21 markets (including the remaining 13 bubble markets) are still not projected to have positive equity by 2013, this is five fewer markets than the year before.
This study, however, notes that this basic analysis of equity accumulation used in the original paper and subsequent updates relies on rents increasing at 3% a year. The demand for housing, however, generally declines with rising unemployment and falling incomes since fewer households form, households double up in units, and some households become homeless. All of these factors are likely to moderate the growth in rents in 2009 and perhaps beyond. In some areas average rents may even decline.
In light of these current economic trends, this paper takes the declining economy into consideration by doing a second analysis using 2009 rent projections that take variables such as employment and rental vacancy rates into consideration. The authors conducted a comparative analysis of 40 cities for which there were comparable data to see how the ability of households to accrue equity changes under these new assumptions. They found that the alternative projections generally still lead to increases in equity, but these increases happen at a slower rate, meaning that homeowners will be worse off if current market trends continue. Most alarming is that in some cities, homeowners who would expect to see gains in equity under the old assumptions may actually find themselves facing a loss when the failing economy is taken into consideration.
This comparative analysis emphasizes the fact that market stabilization will only occur if the broader economy recovers. In light of this, the authors provided policy recommendations such as the need to focus on stimulating the demand for housing through increased employment and incomes and not simply by incentivizing home purchases through homebuyers’ tax credits. The authors also recommended implementing policies that keep people in their homes, such as the Right-to-Rent proposal, which would give homeowners who are foreclosed upon the option to remain in their homes as renters for an extended of time. Finally, the authors recommend capitalizing on lower home prices to provide more affordable housing with a call to fund the National Housing Trust Fund. This program could establish long-term affordability for those who will continue to need help after the economic recovery. It can also serve toaccelerate the recovery by providing jobs and absorbing excess housing.
The full report, “Hitting Bottom? An Updated Analysis of Rents and the Price of Housing in 100 Metropolitan Areas,” by Danilo Pelletiere, Hye Jin Rho, and Dean Baker is available at: www.cepr.net/documents/publications/100city-2009-08.pdf