Money, Financial Markets, and Monetary Policy
On March 21, the Federal Open Market Committee recast its perspective on the housing market. Its previous statement (January 31) noted that “some tentative signs of stabilization have appeared in the housing market,” but its most recent statement presented the less optimistic view that “the adjustment in the housing sector is ongoing.” Below, we examine one element of the issue, recent trends in housing prices.
After rising at an increasing rate since 1992, home prices decelerated sharply at the end of 2006. This reversal occurred across all housing price measures, regardless of whether the measure controls for changing home quality, whether it uses the median or the mean home price, and whether it is based on appraised values or actual sales. For example, the National Association of Realtors measure, which gives the median sales price but does not adjust for quality, reported the largest drop. The smallest drop was reported in the Office of Federal Housing Enterprise Oversight Index, which is based on repeat sales and uses both appraised values and actual sales. A third measure, compiled by Standard and Poors, is based on the Case–Shiller method and samples a smaller set of housing markets. Like the OFHEO, it uses repeat sale prices, but leaves appraised values out of its calculation.
The nationwide housing price indexes conceal noteworthy regional variations. The National Association of Realtors reports that the median price of a single-family home in the West is roughly double that of a comparable home in the South or Midwest. Although home prices in the West and Northeast are higher than in the South or Midwest, their growth rates are also more volatile: They have posted both the highest and lowest changes at various periods since 1969.
One explanation of regional home-price differences across regions is offered by Morris Davis and Michael Palumbo. They separate home values into two components, the value of the physical structure and the value of the land. Their view is that the amount of land on which structures may be built is ultimately fixed, so its supply is relatively inelastic. That is, the supply of land cannot increase even if the price rises sharply. One should thus expect land values to increase most in areas where housing demand is high and land supply is limited.
The charts below, which are based on data available through 2004, show that land values have increased more rapidly than those of physical structures, which is consistent with the supply of land being less elastic than that of structures. Although growth rates in structure values have been fairly similar and stable across regions, land values on both coasts have accelerated significantly. This means that the driving force behind home price growth is the value of the land rather than the structure itself. Except for the Southwest, where land is relatively abundant, land’s share of total home value has increased in all regions.
As the previous analysis suggests, housing prices have the potential for collapsing as the market adjusts—possibly with dramatic consequences for the U.S. economy. Two key questions are: Will housing prices continue to fall? And if so, by how much? For more than a year, the Chicago Mercantile Exchange has offered futures contracts, based on the Case–Shiller Index of housing prices in 10 cities. Some of the cities in the sample are among those with the sharpest price increases and may not characterize the housing market as a whole. The composite of such futures supports the FOMC’s most recent statement, that “the adjustment in the housing sector is ongoing”—as well as the expectation that it will keep going.
Economic Trends is published by the Research Department of the Federal Reserve Bank of Cleveland.
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