davis-om-rupert

davis-om-rupert - July 2007 Federal Reserve Bank of...

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What’s Really Happening in Housing Markets? by Morris A. Davis, François Ortalo-Magné, and Peter Rupert July 2007 ISSN 0428-1276 R ecent trends in house prices have induced a certain amount of hand- wringing among leading econo- mists, policymakers, and bloggers of some repute. In the eight-year boom ending sometime last summer, they warned that house prices were ris- ing much faster than ever before, and that such appreciation was unwar- ranted. As a consequence, these com- mentators are predicting that prices will fall, perhaps disastrously so. According to the most widely cited historical data on house prices (com- piled by Robert J. Shiller for the 2005 edition of his book, Irrational Exu- berance ), house prices were roughly f at from 1890 to 1997 (after adjust- ing for in f ation), but since 1998, they have climbed 6 percent per year in the aggregate. Adding to analysts’ sense of trouble is that the rate of house-price appreciation over the boom has varied widely across the United States. The more populated coastal states, such as California and Florida, have experienced nominal gains on the order of 10 percent per year, whereas prices in Midwestern and interior states, like Michigan and Nebraska, appreciated approximately 4 percent per year. The acceleration of prices in the aggregate re f ects the fast growth of house prices in the coastal states, so the argument goes, but because growth in house prices has outpaced the growth of residents’ income in these states, analysts argue that the rise in house prices is not sup- ported by economic “fundamentals.” Their observations imply that house prices on the coasts, and therefore in the aggregate, should fall to be more in line with income and fundamentals. But there is a problem with the data on which these projections rest. They are inaccurate in a particularly important period—the 1970s, a decade which, as it turns out, does offer a precedent for the current situation. A different source of data on housing prices sug- gests that a housing boom similar to the 1998-2006 boom occurred some- time between 1970 and 1980. As for what might be behind the latest housing boom, two reasonable expla- nations spring to mind. One has to do with the price of land, and the other with relaxed credit constraints. The value of the land on which a house sits contributes a part of the total price of a home. While housing structures are reproducible with little additional cost, land is in F xed sup- ply. To understand changes in house prices, it is necessary to study the price of residential land. Data indicate that the real price of land has been marching steadily upward since 1950. If the 1998–2006 boom to house prices re f ects demand for housing- related amenities, then the data on land prices argue that this boom is a continuation of earlier trends.
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davis-om-rupert - July 2007 Federal Reserve Bank of...

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