Robert Shiller on why house prices will continue to decline

 Because the real estate market doesn’t move as quickly as others.

NYT June 6

HOME prices in the United States have been falling for nearly three years, and the decline may well continue for some time.

 Even the federal government has projected price decreases through 2010. As a baseline, the stress tests recently performed on big banks included a total fall in housing prices of 41 percent from 2006 through 2010. Their “more adverse” forecast projected a drop of 48 percent — suggesting that important housing ratios, like price to rent, and price to construction cost — would fall to their lowest levels in 20 years.

Such long, steady housing price declines seem to defy both common sense and the traditional laws of economics, which assume that people act rationally and that markets are efficient. Why would a sensible person watch the value of his home fall for years, only to sell for a big loss? Why not sell early in the cycle? If people acted as the efficient-market theory says they should, prices would come down right away, not gradually over years, and these cycles would be much shorter.

But something is definitely different about real estate. Long declines do happen with some regularity. And despite the uptick last week in pending home sales and recent improvement in consumer confidence, we still appear to be in a continuing price decline.

There are many historical examples. After the bursting of the Japanese housing bubble in 1991, land prices in Japan’s major cities fell every single year for 15 consecutive years.

Why does this happen? One could easily believe that people are a little slower to sell their homes than, say, their stocks. But years slower?

Several factors can explain the snail-like behavior of the real estate market. An important one is that sales of existing homes are mainly by people who are planning to buy other homes. So even if sellers think that home prices are in decline, most have no reason to hurry because they are not really leaving the market.

Furthermore, few homeowners consider exiting the housing market for purely speculative reasons. First, many owners don’t have a speculator’s sense of urgency. And they don’t like shifting from being owners to renters, a process entailing lifestyle changes that can take years to effect.

Among couples sharing a house, for example, any decision to sell and switch to a rental requires the assent of both partners. Even growing children, who may resent being shifted to another school district and placed in a rental apartment, are likely to have some veto power.

In fact, most decisions to exit the market in favor of renting are not market-timing moves. Instead, they reflect the growing pressures of economic necessity. This may involve foreclosure or just difficulty paying bills, or gradual changes in opinion about how to live in an economic downturn.

This dynamic helps to explain why, at a time of high unemployment, declines in home prices may be long-lasting and predictable.


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6 responses to “Robert Shiller on why house prices will continue to decline

  1. Cos Cobber

    Regarding Japan, consider this; i) they have no population growth in the short term and decline anticipated in the long term and ii) their xenophobic ways prohibit substantive immigration.

    Conversely, America has among the highest birthrates among industrialized countries (thank you SUVs and Mini Vans which are poised to be sin taxed into oblivion?) and more porous borders / immigration policies.

    An extended period of decline seems more likely than not, but anything matching Japan’s decline seems less likely than the article gives credence too.

  2. anonymous

    Shiller tends to be a voice of reason re: housing

    This wkend’s Barron’s Abelson column also references some work by Tilson and Field Check Gp about struggles of higher-end housing mkt

    To-date, much media attn has been on low-end foreclosures and house prices but little focus on illiquidity and distress in high-end mkts throughout US

  3. Old School Grump

    Being the old-school grump that I am, I like Shiller’s explanations for house owners’ “snail-like behavior” because I think it signals a return to the old-school way of looking at your house as — taa daa! — a place to live that you a) like, and b) can afford.

    Imagine that!

    Your house’s $ value may rise or fall, the tax angles of home ownership may change, you may note ruefully the woulda-coulda-shoulda- opportunities that you let pass you by,
    if you insist on thinking of your home as a readily-tradeable asset that you’re supposed to squeeze every possible 32nd out of, rather than a place you’re happy to come home to at the end of the day … well, hell, you might as well sell it now (even at a steep loss) to see about discount ownership opportunities at those Crown Heights, Brooklyn “luxury condos” being turned into homeless housing that CF posted about a few days ago. Or the begging-for-buyers “luxury condos” in Hoboken we talked about here six months ago… I’ll bet their pricing is quite good now.

    Really, folks. Buy a house you can afford in a place you want to live. Ignore magazines/financial news features/TV shows that tell you to do ANYTHING about your home other than maintain it. Don’t feel pressured to decorate as if the Architectural Digest Taste Police and their camera crew are going to pull a surprise visit; they aren’t. And don’t forget that no matter how grand your house is, you’re still not part of the Hapsburg dynasty; you’re just YOU, living there, padding into the kitchen in your sweatpants at 11 p.m. looking for those Girl Scout Thin Mints you swear you put in the freezer back in March.

  4. fred

    dont need to move to crown heights or hoboken, when putnam park/hill will suffice.

    And anyway there is a HUGE difference between buying a home and imvesting in a house.

    Most of the “houses” CF dithers about have flipped two or three times in the past 10 years.

    unfortunately, when the speculative “house” market crashes, it take its toll on “home” prices too.

  5. anon 1

    Old School Grump – you are so formal! I don’t bother to put on sweatpants at 11 pm when I’m looking for a snack… Speaking of which, plates of thin mints left enticingly around in homes might move a few of them… Or throw in a few dozen boxes to seal a deal.

    Cos Cobber – yeah, the Japanese example is probably too extreme. Instead of decling prices for 15 years, I’m thinking maybe…only 8 years. Good times ahead! I guarantee you that birthrates and immigration in the U.S. are both going to decline significantly. Lack of shelter (foreclosures), healthcare, food, and jobs has a way of doing that.

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