(Ed: This is part 2 of Lon’s analysis of the Denver Real Estate Market. Here he looks at the effect of mortgage rates on the “bubble”.)
3 – Mortgage interest rates,at 35 year lows, enable consumers to purchase more home
Mortgage rates, currently (as of 12/24/08) are hovering around 5.14%, the lowest since 1971. Lower rates make homes more affordable for consumers. Source: MortgageX.com
4 – The basic premise of most bubble analyses, that homes are commodities, is misleading.
Schiller’s analysis assumes that home prices behave like a commodity,such as:
- Pork bellies
- Bushels of corn
In reality, housing has at least two components that differentiate the product and the price that consumers are willing to pay…
- The neighborhood (e.g., school quality, local amenities)
- Size of home (square feet) and quality of finish
The average home in the Denver market has gotten larger and more luxurious in the past two decades, which “brings up” the average home price. This component of the price appreciation is based on sound economics, not speculation.
The “typical” home built in each decade in Denver has different characteristics that influence prices.
You can see the average home built in 2000-2008 sold for over $400,000 while the average home built in 1950’s sold for less than half of that, about $200,000. Why such a difference? Part of the gap is due to amenities. Newer homes have more garage space, are more likely to have central air conditioning, and tend to have more luxurious kitchens and baths. However, most of the gap is explained by the size of the home.
The average home built in the 1950’s is a little over 1,000 square feet while the homes built in the last decade averaged almost 2,500 square feet. The price per square foot consumers are willing to pay for a home is relatively consistent from one decade of construction to the next.
What’s important to know is that these newer, more expensive homes makeup much of the transaction volume in the MLS. The least expensive homes (average = $225,000), built from 1950-1969,are 18% of the market. The most expensive homes, built from 1990 – 2008 (average = $385,000) are 42% of the market volume.
Exhibit eight: Newer, more expensive homes make up a large part of the sales in the MLS.
Source: Your Castle Real Estate, Metrolist
In our analysis, 22% of Denver’s 36% increase in price can be traced to larger, more expensive homes built since 1990. Consumer willingness to pay more for larger, more luxurious homes isn’t speculation. It is sound economics.
From this viewpoint, in the worst case scenario, Denver’s home prices would need to fall about another 14% to reach the long term average historic price (after adjusting for inflation). Initiatives from Washington will likely cushion the market so that it doesn’t need to fall that much more. We expect the average home price to decline a bit in 2009, but not this severely.