Tuesday, December 11, 2007 3 comments ++[ CLICK TO COMMENT ]++

House Price-to-Rent Chart

A commonly used valuation measure for stocks is the P/E ratio. Well, the comparable ratio for housing is the home-price/rent ratio. It's not exactly comparable and the drivers of stocks and housing are somewhat different but, nevertheless, it's a good ratio to use for newbies like me. Since I'm trying to pick a bottom in housing--or at least avoid a falling knife--I think looking at the home price to rent ratio is worthwhile as a crude measure.

The Wall Street Journal has the following chart of the home price to rent ratio (thanks to Paul Krugman's blog for the initial mention of Barry Ritholtz's blog, who references the WSJ chart :) ):

This is a scary looking chart. It could take a while for that ratio to go back to historical norm. Similar to Paul Krugman, charts like these is what made me believe that housing was in a bubble. People simply won't be able to afford houses when the ratio expands. This ratio was put into practical terms when I started reading stories about young couples with jobs couldn't afford a starter home in San Francisco or New Jersey.

I should note that, similar to P/E ratios, this ratio can stay elevated if some factors work in their favour. For instance, P/E ratios can be high if interest rates are low. What can make the home price to rent ratio stay high is if income rises. But, unfortunately, American worker compensation has been flat for many years. My guess is that worker compensation as a percent of GDP will rise in the near future, while corporate profits as a percent of GDP declines, but even that may not be enough to keep the house price to rent ratio elevated.

Housing Boom Started in Early 90's

On a sidenote, anyone who thinks the housing bull market started in 2000's is sorely mistaken. Although you can't really tell from this chart, the boom started in early 90's. What this chart does tell you is that the price/rent ratio started expanding around that time as well. Some people like to pin the blame on the Federal Reserve's lowering of rates in 2003 for the bubble but the reality is that housing was already in a boom by then. What happened in 2003-2005 is that, as is the case during the final stages of any bull market, the shady deals, questionable transactions, and rapid price appreciations started materializing.

You made almost as much money from 1992 to 1999 as you did from 2000 to 2007 (I'm talking about housing-related stocks and not house prices, although both are strongly correlated to each other). This chart of Countrywide (CFC), a leading mortgage lender, and Pulte Homes (PHM), a leading homebuilder, shows the move I'm talking about (note that this is a log graph so equidistant spaces mean equal percentage gain). The 90's increase was around 1000% (10x) versus around 800% (8x) in 2000's. I suspect if you bought a house, as opposed to a stock in a housing-related company, you probably also made more money from the bottom in 1991 to 2000 than from 2000 to 2007 (I don't have a chart handy and am guessing here).


3 Response to House Price-to-Rent Chart

December 12, 2007 at 2:23 PM

I think the housing market will stay stagnant for years. I was looking at potentially some investment into houses in the Stockton area, arguably one of the epic centers of the housing bubble. After evaluating prices at auctions, decided it was not worth the money. In Sept. time frame, the auction prices were about 25% to 30% off the peak. On the other hand, housing prices in the SF/San Jose are have bearly budged, so subPrime lenders would not have lost much in a foreclosure.


December 13, 2007 at 10:09 AM

Sorry for my ignorance but where is Stockton? California?

December 13, 2007 at 12:29 PM

Stockton is in central CA.


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