By Lon Welsh, Your Castle Real Estate
(Ed: Lon is a professional statistician who knows how to analyze the real estate market. He is a Blogger at All Denver Real Estate and Active Rain. He works with home buyers, sellers and investors. Check out his profile here. This is the first of a two part analysis. Part two will be published later in the week.)
There has been a lot of discussion about the real estate bubble and how much home prices need to decline for the bubble to be corrected. While this story has a lot of sources, many trace back to the work of a Yale economist, Robert Schiller. He took the average price of a home, since1890, and adjusted for inflation (see exhibit one). His work suggests that the average US home price has declined 16% from its peak a few years ago, but that another 52% in price decline is needed to get back to historical levels.
In our view, Denver’s homes will have a smaller correction than the overall US market, for four reasons we’ll explore in this article:
1 – Denver’s prices rose less than the US in this real estate boom.
2 – Real income growth in Denver outperformed the US; this enables higher real estate prices.
3 – Mortgage interest rates, at 35 year lows, enable consumers to purchase more home.
4 – The basic premise of most bubble analyzes, that homes are commodities, is misleading.
We’ll explore each in turn.
1 – Denver’s prices rose less (after recent declines) than the US average in this real estate boom
Since 1971, the average home price in Denver has increased 6.4% per year BEFORE inflation. However,inflation averaged 4.6% per year. When you adjust out the impact of inflation, Denver’s average home price has increased just 1.7% since 1971. Looking at the recent boom in home prices, the average price in Denver is up 36% after inflation.
Exhibit two: Denver Homes -before and after inflationhttps://www.larryhotz.com/files/2009/01/lon2.gif
Source: Your Castle Real Estate, Metrolist, Bureau of Labor Statistics
When you combine this information with Schiller’s chart, you see that Denver’s market didn’t go as high as the US and we have since corrected 13% (see exhibit three) after inflation.
Do home prices need to return to their levels (inflation adjusted) of 1997? Do prices need to drop another 36%? Perhaps not. The next three sections reveal why.
Source: Your Castle Real Estate, MetroList, Robert Schiller, Bureau of Labor Statistics
2 – Real income growth in Denver outperformed the US; this enables higher real estate prices
After adjusting for inflation, between 1996 and 2007, Per capita income growth in Denver grew 25% while the US average only increased 21%. Over time, home prices have grown slightly faster than inflation. The size of the gap is about the same as real income growth. As families make more money (after inflation), they tend to spend much of it on housing (in the form of larger, nicer homes). As a result, Denver’s market likely needs less of a correction than the US market.
In this eleven year period, Denver enjoyed the best of all worlds: incomes rose faster than average while home prices rose less than average. Home price affordability improved for the average Denver household.
In my next installment we will explore mortgage interest rates effecting the Housing Bubble in Denver and whether homes are really just a commodity as Schiller contends.