Thursday, January 03, 2008

How far to fall?

Bad news for holders of mortgage-backed securities! It looks like an average 15% (nominal -- larger in real dollars) price decline is required before price to rent ratios are back to historical ranges. Actually, that guesstimate assumes a 5 year "orderly" adjustment. The real figure of merit is that rent to price is down to 3.5% from a historical range of 5 to 5.5% How would you like to own an overvalued asset that returns only 3.5% (leaving you on the hook for property tax, maintenance, insurance, etc.)?

Via CalculatedRisk: From Morris A. Davis (Department of Real Estate and Urban Land Economics, University of Wisconsin-Madison), Andreas Lehnert, and Robert F. Martin (both Federal Reserve Board of Governors economists): The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing

Abstract: We construct a quarterly time series of the rent-price ratio for the aggregate stock of owner-occupied housing in the United States, starting in 1960, by merging micro data from the last five Decennial Censuses of Housing surveys with price indexes for house prices and rents. We show that the rent-price ratio ranged between 5 and 5-1/2 percent between 1960 and 1995, but rapidly declined after 1995. By year-end 2006, the rent-price ratio reached an historic low of 3-1/2 percent. For the rent-price ratio to return to its historical average over, say, the next five years, house prices likely would have to fall considerably.

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