Wednesday, March 28, 2007

Bear markets: how deep, how long?

Using the S&P/Case-Shiller® Home Price Index for comparable sales of single family homes in the Boston MSA, the peak of the late 80's / early 90's market occured in July 1988. Plotted below in black are the percent price declines in the subsequent 106 months relative to that peak.

The market did not bottom until ~36-48 months after the peak. One way to interpret this plot is that on aggregate, a home purchased in July 1988 would be sold at a loss for the next 106 months (>8.5 yrs). A home purchased when half of the ultimate price decline was complete (-8% @ ~24 months) would be sold at a loss during roughly the next 56 months (>4.5 yrs). These are NOT inflation adjusted prices. This does NOT include commision costs.

There is no reason to expect history to repeat itself exactly, but the yellow bars on the plot show very similar price declines from the recent September 05 market peak. The arrow indicates the most recent data release for January 2007. The final five bars in the plot correspond to the CME futures for the Boston MSA for the next 12 months (as of March 27).

Only time will tell whether the current bear market wil match or exceed the severity of the previous cycle. But the plot does provide cautionary evidence that purchasing in a falling market is no protection from potential losses for extended durations. Next time someone tells you "now is a great time to buy," keep this in mind.


notsofastlouie said...
This comment has been removed by the author.
notsofastlouie said...

You compare the peak of the housing market in 1988 to 2005 and imply that thecurrent housing correction might last as long (3-4 years). But today's conditions are totally different:

1. 1988 saw a massive imbalance between the home construction and demand rate. (Prior to the Tax Reform Act, which took effect in 1987, developers were allowed to accelerate depreciation of real estate and pass through resulting (non-cash) losses to passive investors. As a result many multi-family construction projects were underwritten for tax considerations, rather than market fundamentals, causing overbuilding and hence downward pressure on prices.)

2. The 1988-1992 period also saw a massive economic recession, during which period millions of jobs were lost. This resulted in a contraction in demand at a time when homes and rental units had been built largely for tax reasons.

By contrast, we continue to see job growth (60,000 jobs in MA in the last 2 years), which has resulted in the continued absorption of new construction and reduction of homes for sale inventory. Furthermore today the construction rate in MA is equal to or less than the demand implied by job growth.

The risks in 1988 had to do with oversupply; today they have more to do with liquidity in the mortgage markets (eg. the possibility that interest rates will rise: we are already seeing a tightening of credit, which implies a higher interest rate for the median borrower).

The conditions, issues, and risks today could not be more different from those of 1988-1992.

indigo said...

Louie, I'm confused. Did you just say:

this time its different?

Should we all trust you on this one and bet the farm on the CME futures, since they must be wrong in predicting future declines?

Should we declare that it is pointless to consider what has happened in the past, beyond pointing out that the past was different?

Are you telling us that:

now is a great time to buy?

cary said...

a good time to buy. ya, right.prices are going down. i have been watching land prices on the cape and lots that where priced at 395k a year ago can be had for 270k today.arms resetts and foreclosures are going to bring the market down even we are heading into a credit squeeze.

cary said...

this chart says it all!!

indigo said...

Great chart Cary. Thanks. Lots one can read into it.

1. Amazing how the subprime collapse came very early in the reset schedule with nearly 2 years of pain still in the pipeline. (Probably due to the criminal loans who's borrowers couldn't cover payments from day one.)

2. Also with the Alt-A and Option ARM resets 2-4 years off, drammatic foreclosure patterns in that market may be 3 years out. While that market seems to be plummeting already, its possibly more due to constraints on buyer financing and buyer market expectations, than sellers getting squeezed.

So while a more modest Dorchester house could probably be grabbed up in a year or two, it may be 3-4 years before that Cambridge or Wellesley house would look appealing.

3. Another interesting question is thinking how this chart changes in time. Since it drops of at 60 months, last year's 5/30 ARM must have been much more attractive than a 7/30. As the effective mortgage yield curve inverts more, (meaning only 1 & 3 year ARMs are cheapter than fixed,) one may expect more new supply only adding on the shorter term.

J said...

Thank you for these charts. Viva la MHM blog.

J at Inexpensive Home Building

notsofastlouie said...
This comment has been removed by the author.
notsofastlouie said...

Indigo: In my above post I nowhere say that now is a good time to buy. I merely point to the radically different circumstances of today's market as compared to 1988-1992. The primary risks in the housing market today relate to interest rates and job growth. To be clear, if rates go up (eg. the credit market tightens) OR if job growth slows down, demand will not keep up with the construction pipeline and sales and prices will fall.

But rates today are low, and the direction of rates is notoriously unpredictable. And for the moment job growth is remarkably robust (30,000 jobs in the last 12 months in the Boston metro area). By contrast in 1988 there was tremendous overconstruction due to a flaw in the tax code, and 1990-1991 saw millions of job losses. Those conditions, which precipitated and aggravated a serious correction in the housing market, do not hold today.

We can only make market predictions based on all supply and demand side data. This blog focuses on some of the relevant variables: current supply inventory, historical demand, the ratio of these as months of suply, and various affordability ratios (principally price to income).

But as I have long argued, the blog does not focus on other critical variables: future supply (as measured by permits, starts, and deliveries) and future demand (as measured by net job growth times the home ownership percentage). This additional data forms the core of reports used by real estate investors (cf. the Meyers Group's reports - see their web site).

Where I have said that it is a good time to buy, I have qualified it as follows: it's a good time to buy only if one is planning to hold for 6 or more years. Consider the following:

1. On the current pace of job growth, future demand (30,000 jobs per year) will fully absorb and perhaps exceed future supply (in 2006 only 15,000 units were built, and permitting is sharply down).

2. Today home prices relative to household income are about 15% higher than their historical average, but mortgage payments relative to income are at their historical average. The disparity results from interest rates that are lower than their historical average.

3. If interest rates revert to the mean over this period, mortgage payments will increase by approximately 10%-15%. This variable alone would result in a 10%-15% decline in home values. But this correction would be offset by wage-driven inflation. Household income in Boston has historically gained by 4% a year (inflation plus 1% in productivity increase). Rents and the fundamental value of a home ought to follow and have, over time, increased with household income, all other variables held equal.

Accordingly the future value of a home would be affected as follows: a) a 10%-15% correction for interest rates, offset by b) 4% growth per year compounded annually, or 25%-30% in aggregate over 6 years. The net value of the house will still climb by 10%-20% over 6 years. If you put $40,000 down on a $400,000 condo, even with interest rates at 7.5% that condo would be worth $440,000-$480,000. Commisions ould eat up a piece of that, but the balance still amounts to a nice capital gain that is tax free.

notsofastlouie said...

As far as sub-prime loans: According to the Census (see below link), 1 in 3 homes in MA have no mortgage. Of those that do have a mortgage, per the below Boston Globe article, 12% are sub-prime. About 1%, or 20,000, borrowers were late on payments at anytime in the last 12 months, and historically only 1 in 4 of those will actually result in a foreclosure - that's 5,000 homes.

Even if this number were to double, the additional for sale inventory would increase by 10,000 homes over a year, or possibly 6,000-8,000 at any given time. Given that statewide housing inventory has been around 50,000 units at any given time, the incremental inventory would be significant, but far from fatal to the market.

It's also important to keep in mind that the foreclosure activity is likely to be concentrated in specific markets with a high number of subprime borrowers - places like Lawrence, Brockton, etc. Inventory from foreclosures would not increase by much in the urban core market, where foreclosure notices and actual foreclosures have been extremely limited.

Boston Globe article:

Census site:

cary said...

if anyone is interested in seeing what homes sold for go to and click on recent sales. you might have to register (free). recent sales shows what it listed for and what it sold for. good research tool!!

cary said...

the nar and fed fudge numbers when ever they get a chance to so if you want to see "real" numbers go to the registery of deeds. thier numbers do not lie. i track plymouth and barnstable countys. go to

click on registers report

this site shows actual "foreclosure deeds" filed and all sales in plymouth county
this site shows sales,click on registerys news
if someone has better info on researching pleace let me know thanks!!

notsofastlouie said...
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notsofastlouie said...


37,000 jobs created in MA in the last 12 months.

37,000 new jobs x 75% (3,258,000 jobs in state / 2,448,000 households in state on 12/31/06) = 27,750 new houses needed for new job holders.

But 2006 permits in the state are for only 14,000 new units.

New supply does not meet new demand.This is what is driving the reduction in housing inventory.


Info on # of homes:

William said...


Do you see the link between Mortgage Market liquidity and the Bear Sterns Hedge Fund crisis.

You do realize that this was CMO - or bonds backed by Mortgages. This will lead to banks tightening lending standars - the Banks will have to if they want to sell the Mortgage to the secondary Mortgage Market.

To believe that there hasn't been a lot of building in Massachusetts is complete denial -
My favorite Ice Cream stand in Hamilton-MA is now becoming townhouses.

Are you in Real Estate as a profession or do you own a lot of Real Estate?

msprompt said...

Hi all,

I almost signed a P&S on a Cape Cod cottage but pulled the offer off the table last night. Hard to buy a house you know has an unspecified percentage of loss built right in.

Louie, how come we're assuming that an increase in jobs necessarily means that all those people need/want to buy a house? From what I've discovered, the population in Massachusetts is declining, not increasing. PLus, what kind of jobs are they? I'm not sure if job growth is the marker. But I'm no economist so any insight you can give is appreciated.

Does anyone out there think now is a good time to buy, what with the concern over mortgage co. liquidity and rising interest rates?

notsofastlouie said...
This comment has been removed by the author.
notsofastlouie said...


Housing permitting in the state is down from 9,345 units (year to date May 2006) to 6,773 (units year to date May 2007). Source:

The total number of housing units permitted last year was 19,805. On trend we will build 30% fewer this year. So you are seeing less building. The question is, is this construction level enough to meet rising demand? I'll try to answer that question below:


If one assumes that the ratio of job holders to households (the rate of household formation) will not change much in the short-term, then one can calculate demand for housing as follows: number of new jobs (37,000 ttm) divided by the current ratio of job holders to households (75%) = 27,750 new housing units needed. This is the standard demand measure in the housing industry.

If we only build 15,000 units this year, we will have built just over half the required number of housing units. This suggests continuing decline in the existing number of vacant housing units.

Now, many housing units permitted are multi-family buildings geared for the rental market (lots of the new construction in Boston is rental). Similarly, many new job holders that form new households will want to rent. The relative stability in that rate and the rental vacancy rate suggest that there is no mega-shift in the number of new job holders that rent vs. own.

Either way, barring a major increase in construction and/or a slowdown in job formation, there will not likely be enough housing in 2008-2010 for either the ownership or rental markets.

As to your other questions: TYPES OF NEW JOBS: the new jobs are in high-paying fields: professional and business services, health and education, information, etc.

The Massachusetts economy is performing well, driven by these sectors:

Incomes are increasing by 3-4% per year (which increases the money people have to make monthly or rent payments, thus the underlying home value tracks income increases.)

POPULATION: Reports that the Massachusetts population was declining were put into serious doubt when the Census bureau revised its Boston estimates to show that the city's population had actually been rising. Source:

And the Census continues to forecast population growth for the state as a whole and reports that I can't locate at the moment indicated slight population growth for the state in 2006.

DO I THINK IT IS A GOOD TIME TO BUY? Certainly the supply/demand fundamentals are strong. It's hard to make the leap in weak markets (like the Cape) but the best investors always buy when things are soft and bargains can be had.

The most unpredictable element of risk is interest rates. But as I argue on an earlier post, if you hold for 6 years you will make a strong return on investment even with a substantial increase in interest rates. And the gain may be tax-free.

Ultimately everything depends on whether you think Massachusetts is well positioned for growth in the next 5-10 years. I think it is brilliantly positioned.

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Dan McGuire said...

Just discovered your blog. We need it now more than ever. Are you going to post again? said...

How much is your home worth? Well, it all depends where you live.

The real estate market is still shaking. New data suggests that home prices have hit a new record low. In every new study that comes out, homeowners from Miami, to Las Vegas, Phoenix and Los Angeles, have seen their home value go lower every time.
Is that disappointing? Of course it is.
Should we sell? Is not a good time.
Should we stick to it? Yes, if you can.
Have we hit bottom? Nobody knows.

Banks are facing their worst foreclosure crisis.
Don’t take me wrong, it’s good if you are in the market to buy a home for yourself or if you are an investor, but if you are not, and you own a home, most likely the value of your property is down at least 15 %.

Why do banks care if you are loosing your home? By having to sell repossessed homes, banks have to literally slash their prices down. It gets very costly for them, after all, they have to pay property taxes, maintenance costs, and whatever utilities that need to be paid, all of this expenses for a house that it’s just sitting there, vacant, and the bank is getting nothing in return.

The latest study by the S&P/Case-Shiller Home Price Index of 20 cities, revealed the news that for 22 consecutive months home prices dropped. Only from April to May, 2009 the decline was of 0.9 %

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