This week's Big Sky Business Journal has an article on housing. This is the first major housing update since the BSBJ's September article, which I critiqued near the bottom of this blog.

Unlike the September article, which only quoted many local Realtors, the new article contains a contrarian voice.. me! There are also some good quotes from Paul Polzin. Read it and see what you think. Thanks to Evelyn for an interesting article, and for quoting me.

I have two responses that I would like to post here.

Rents set to skyrocket?

In response to my assertion that the price/rent ratio is out of line with historic norms, here's what real estate agent Howard Sumner has to say:

That there is a huge disparity between the current rental rates and mortgage payments, is not something with which Sumner would disagree. His figures show a disparity of about $650 a month.

But, that means only one thing to Sumner: "People will be shocked at the increases in rent over the next 90 days". The "softening" in the rental market, Sumner attributed to a jump in the number of multi-family units that has been built in the recent pass.

Sumner recognizes that this disparity is a problem.  That's a good start.  But instead of believing, like I do, that housing is overvalued, he claims that renters will see shocking rises over the next few months.  This claim is made with no data to back it up.

Barring a major shortage of rental units, rents are generally determined by local wages.  There can be no speculation or risky loans .  Rental rates can only be as high as people can afford.  This is why the price/rent ratio is so crucial.  While rents tend to steadily track wage growth, house prices can fluctuate much more and get out of line with fundamentals.

We really need to get some data on rental vacancies.  I'll see what I can do.  In the meantime, I did some quick looking into the Billings Gazette print archives.  I looked at single family home rentals in print Gazette classifieds from 2003 through 2007.  For each year, I looked at the last Friday in February.  Here are the numbers I found:



If indeed rents were set to skyrocket, you would expect very tight supply. Instead, we see a fairly large number of houses for rent. The number is pretty much in line with what we've seen for the last few years.

Interestingly, several of the houses for rent are advertised as brand new and never lived in. Because there's so much inventory for sale out there, many units are being rented out since thay cannot sell. This is especially true in the condo market. Most downtown condos are for lease as well as for sale. Many other condo projects around town are having trouble selling, and are going up for rent. There are a lot of vacant units out there.

I don't see where Sumner gets his idea that the price/rent problem is going to be solved by rising rents. Unless he provides some hard data on why rental rates are going to have "shocking" rises, I'll be skeptical until I see it.

Have interest rates kept housing affordable?

Later in the article, Sumner takes on my claim that housing is unaffordable.  Here's the exchange:

But affordability is exactly the problem with the price of housing, claims Armknecht. He stated, "Billings house price index, published by the Office of Federal Housing Enterprise Oversight shows house prices up 50 percent in the last five years. Most estimates show wage inflation to be around 15 percent during that time. Home prices have risen so fast that incomes can no longer support them."

Sumner's numbers indicate quite the opposite, much even to his surprise, he said. With the average price of a home climbing from $114,000 in 1999 to 180,000 in 2005, it may indeed appear that house prices are out stripping the average buyers ability to buy. But consumer purchasing power has been advancing at the same time, said Sumner. The median family income in Billings increased 18 percent, while interest rates dropped 20 percent from 1999 to 2004. A homeowner who could afford a $141,129 in 1999 could afford a $195,374 home in 2004.

I believe that Sumner's analysis is muddled, misleading, and sidesteps my point.  Based on the phrase "Sumner's numbers indicate quite the opposite", he needs to show that my statement "Home prices have risen so fast that incomes can no longer support them" is incorrect.

To do so, he says that consumer purchasing power increased. Since wages have trended upwards and interest rates generally downward, he is correct. However, he conveniently only looks at the years 1999 through 2004, ignoring the trends and data since then.

I will assume that "consumer purchasing power" is a function of wages, prices, and interest rates.

Interest rates are at the crux of his argument. Rates dropped from over 8% in 2000 to below 5.5% in 2003. This did make housing more affordable. But what happened since then? Interest rates were fairly flat, then started ticking upwards. Did prices slow after 2004? No, they roared through more huge increases in 2005 and 2006.

Sumner suggests that housing took off because of low interest rates.  I believe that prices shot up because of other speculative factors.  The continued price increases in 2005 and 2006 in the face of modest wage inflation and rising interest rates support my view.

Here's a table with some figures:



There are lots of numbers here, but bear with me.  Let me explain the columns. First column is the year. Second column is the average sale price in Billings for that year (source: Prudential Floberg Realtors). Third column is the average interest rate for a 30-year mortgage for that year (source: Estimate from Investech.com research). Fourth column is the income needed to afford the average sale price, using the year's interest rate (source: Billings Association of Realtors on-line calculator assuming 0 down, 1% property tax, and 0.5% insurance). Finally, the fifth column has each income adjusted back to 1999 dollars by taking into account 3.5% wage inflation per year.

That's a lot of numbers, but the most important column is the final one. This should be a good measure of "consumer purchasing power" since it accounts for both wages and interest rates. If in fact houses are as affordable now as in 1999, then numbers in the final column should be fairly flat. Instead, we see that the income needed to buy the average house was 21% higher in 2006 than in 1999, even when factoring in lower rates and wage inflation.

Housing is still unaffordable, even with lower interest rates. I don't think "Sumner's numbers indicate quite the opposite" at all. What do you think?