“Each year, our survey has asked: “On average over the next 10 years, how much do you expect the value of your property to change each year?” In 2004, a boom year, the average answer was a gain of 12.6 percent, but in succeeding years the figure began to decline, bottoming at 4 percent in 2012…
…Understandably, people back then were excited to think they could borrow 90 percent or more of a home’s value at around 6 percent interest and receive an annualized return of more than 12 percent. That would have been quite a coup. But those expectations were about as wrong as wrong could be. People were living in a bubble, and the bubble eventually burst……Expectations are rising again, but this is nothing like the run-up to the 2006 peak…The biggest housing boom in American history, from 1996 to 2006, came after the decline in overall inflation (and interest rates) since 1980…..So far, we’ve been talking about objective issues. But changes in our speculative mentality — the driver of all those long-term expectations for price changes — are likely to be much more important, because expectations can feed a self-fulfilling prophecy until a bubble bursts……Despite having no objective way to know the future — and despite an apparent disregard for the reality that housing hasn’t been a great investment over the long run — people are constantly changing their opinions about long-term trends. And, lately, they’ve become somewhat more optimistic.”, Nobel Laureate in Economics Robert J. Shiller, “Home Buyers Are Optimistic but Not Wild-Eyed”, New York Times
“There is much I take exception to in this article; in particular his negativity in regards to a home being a good long-term investment, without any historical return-on-investment data being provided. (The home-buying application I hope to launch in the next few months, will be my response.) I am blogging this article, because again the truth is emerging. This housing bubble/bust article barely makes mention of mortgage lenders and certainly debunks the incorrect mainstream view that they were a primary cause. Instead, Nobel Laureate Shiller mentions prominently the multi-decade decline in inflation expectations (and interest rates) engineered by the Fed, expectations of home price appreciation by consumers, and the fact that future nominal home price appreciation is impacted significantly by the Fed’s 2% inflation goal. (Roughly half of current consumer expectations for nominal home price appreciation is caused by the Fed.) So, its irrational consumer expectations (Shiller: “people back then were excited”, “no objective way to know the future”, “speculative mentality”) and the Fed that caused the housing bubble/bust; not the greedy and reckless bankers/mortgage lenders? I am also coming to the conclusion that Fama is right and Shiller is wrong. I don’t think consumers are irrational. In markets where asset prices are dominated by consumers, like homes, I just don’t think these consumers have access to cash flow models/scenarios that institutional investors would demand. And even worse, these consumers’ “advisors” (Realtors, mortgage lenders, appraisers) have a big conflict of interest; they need them to buy/sell to earn their revenue. (My home-buying application is designed to address this very problem and will hopefully help prospective homebuyers make more informed and rational decisions.)”, Mike Perry, former Chairman and CEO, IndyMac Bank
Home Buyers Are Optimistic but Not Wild-Eyed
By ROBERT J. SHILLER
Most of us don’t add up the short-run investment pros and cons when we consider whether to buy a house; instead, we think about the long-term lifestyle we want.
That makes sense, because once a house is bought, the owner typically stays in it for a decade or more. And, after all, houses are homes as well as investments.
Yet at important points in our lives, we may nonetheless find ourselves focusing on the investment side of housing. Do we want the largest houses we can afford, or should we live modestly — maybe by renting — and invest more money elsewhere?
In making that decision, we’d benefit by knowing what would happen to a home’s value in 10, 20 or 30 years. Unfortunately, short-run changes in home prices are of virtually no value in answering this question. The best we can do is assess recent trends, and look further back into history.
So here’s an update on housing trends, compared with those of earlier years. Or, more precisely, here’s an update on what people think the trends will be. Despite having no objective way to know the future — and despite an apparent disregard for the reality that housing hasn’t been a great investment over the long run — people are constantly changing their opinions about long-term trends. And, lately, they’ve become somewhat more optimistic.
A home for sale recently in Los Angeles. The number of Southern California homes bought for $2 million or more in recent months is the highest on record. Credit Nick Ut/Associated Press
Karl Case of Wellesley College and I have conducted an annual questionnaire survey of recent home buyers in the Los Angeles, San Francisco, Milwaukee and Boston areas since 2003. Since 2012, Anne Thompson of Dodge Data & Analytics has participated. Each year, our survey has asked: “On average over the next 10 years, how much do you expect the value of your property to change each year?” In 2004, a boom year, the average answer was a gain of 12.6 percent, but in succeeding years the figure began to decline, bottoming at 4 percent in 2012. The expected gain rose to 4.2 percent in 2013 and 5.5 percent in mid-2014.
In addition, the Pulsenomics U.S. Housing Confidence Survey, covering the entire country (and involving many cities that may be less volatile than our four), showed that homeowners and renters in July had slightly lower 10-year expectations: 4 percent a year for the next 10 years.
Still another measure of expectations can be found in the United States composite home price index futures contract on the Chicago Mercantile Exchange. At its close on Nov. 30, the contract predicted a 4 percent-a-year increase from November 2014 to November 2016.
These three reports are fairly consistent, and both our data and that of the Chicago Mercantile Exchange show higher expectations than they did a couple years ago. But these new expectations are hardly wild: If inflation ran at 2 percent a year, the Federal Reserve’s target, the expected appreciation in housing would be an inflation-corrected 2 percent to 3.5 percent a year. So at the moment, there is no evidence of extravagant bubble thinking.
Another way of looking at this is to compare mortgage rates with expectations for housing prices. Mortgage rates are low, only 3.93 percent for the 30-year conventional mortgage in early December, according to Freddie Mac’s latest report. Thus, the spread between 10-year expectations for housing prices and this mortgage rate is now very small. Contrast that with a spread of more than six percentage points in the home-price bubble just before the market peak of 2006.
Understandably, people back then were excited to think they could borrow 90 percent or more of a home’s value at around 6 percent interest and receive an annualized return of more than 12 percent. That would have been quite a coup. But those expectations were about as wrong as wrong could be. People were living in a bubble, and the bubble eventually burst. Expectations are rising again, but this is nothing like the run-up to the 2006 peak.
A property in San Francisco. Home buyers in that area, along with Los Angeles, Milwaukee and Boston, take part in an annual survey that asks how much they think the value of their property will change over 10 years. Credit Jeff Chiu/Associated Press
One wild card in housing prices is the future of the mortgage interest tax deduction. While it’s beloved by many taxpayers, it may not last — and if it doesn’t, short-term trends could be affected.
Dennis J. Ventry Jr., a professor at the School of Law at the University of California, Davis, calls the mortgage tax break “the accidental deduction,” put in place largely to help farmers, when there were more farmers than homeowners with mortgages. Back then, there was little if any discussion of the idea that the government should subsidize homeownership. An accidental tax break like this might well be repealed someday. A proposal in February by Representative Dave Camp, chairman of the House Ways and Means Committee, to limit a couple’s deduction to the interest on $500,000 of mortgage principal, is an indicator of what may be ahead.
But if you’re thinking for the long term, this shouldn’t be a major concern. With mortgage rates under 4 percent, and with the median home price under $200,000, according to RealtyTrac, the typical mortgage interest deduction is well under $8,000 a year, far below the 2015 standard income tax deduction of $12,600 for a married couple. Only about 30 percent of taxpayers itemize deductions, and unless you do so, you can’t get this mortgage break.
Edward Glaeser of Harvard and Jesse Shapiro of the University of Chicago found that the homeownership deduction has accrued overwhelmingly to people in the top tenth of the income distribution. What’s more, the deduction hasn’t figured significantly in home-price surges. The biggest housing boom in American history, from 1996 to 2006, came after the decline in overall inflation since 1980 had already made the mortgage deduction much less valuable than it was in previous years. So far, we’ve been talking about objective issues. But changes in our speculative mentality — the driver of all those long-term expectations for price changes — are likely to be much more important, because expectations can feed a self-fulfilling prophecy until a bubble bursts.
Ten years from now, there could be another housing boom or bust. But since 1890, the average appreciation of inflation-corrected home prices in the United States has been only a third of 1 percent a year. That’s why housing hasn’t been a great investment. And in 10 years, it may be almost equally likely that real home prices will be higher or lower than they are today.
Cultural changes — like those brought by the Internet — could also have a profound effect. When our social contacts are increasingly defined by social media, for example, the appeal of living in a permanent physical neighborhood could decline. We don’t really know. This is more sociology than economics.
In making the crucial choice of how much housing to buy for the long haul, we must keep in mind that owner-occupied homes aren’t a surefire investment opportunity. You may want to weigh whether you want to deal with a home’s maintenance, or whether you’re committed to staying in one neighborhood and, maybe, at a nearby job. Those factors may be a source of pleasure — or a burden — over the next decade. In any case, there’s a good chance they will outweigh the financial prospects of an investment in housing.
Robert J. Shiller is Sterling Professor of Economics at Yale.
A version of this article appears in print on December 14, 2014, on page BU7 of the New York edition with the headline: Home Buyers, Optimistic but Not Wild-Eyed.