What is a House in Regina Actually Worth?
By John W. Warnock
October 6, 2008
http://www.actupinsask.org
By now everyone knows that the housing market in the United States has been in steep decline since the peak in 2006. Sales of new and existing houses have been steadily dropping. House construction is down dramatically. Mortgage money has all but disappeared. Lending institutions are only providing mortgages to people with very good credit. Interest rates are rising. Buyers now are expected to come up with 20% or 30% of the value of a house as a down payment.
But our political and business leaders insist that Canada is different – the banks are sound and the “economic fundamentals are good.” Stephen Harper is still proclaiming that the U.S. housing problem will not move over the border into Canada. What can we make of this?
The Canadian housing market
However, the latest figures show that across Canada sales of new and existing houses are down, the price of houses being sold is dropping, and the number of houses listed for sale is rapidly rising. Several studies released in the past couple of months argue that Canadian houses are also overvalued.
Saskatchewan has been the exception. The former NDP government, the current Sask Party government, and the real estate industry have insisted that this province will not experience the same trends in the market and finance seen elsewhere in Canada. The local economy is too good for this to happen.
I recently received the assessment for my old house, built in1920, in and older area of Regina. According to the city’s calculation, based on house sales in the neighbourhood, the value of my house has increased 28% in the past year. I have done nothing to upgrade this house in the past few years, and it has never been renovated.
So how can someone who owns a house, or someone considering buying a house, know what a house is really worth? In researching this issue over the past month, I have found three basic approaches used by economists.
Ratio of the price of a house to household income
Many economists look at the long term relationship between the price of housing and average household income. This can be seen in the widely-cited index created by economist Robert Shiller. Discounted for inflation, Shiller and many other economists argue that historically the price of an average house has been the equivalent of three times the household’s income. When there have been house price booms, they have evened out with subsequent down cycles.
This historic average began to change in the United States in 1996, the beginning of the housing bubble. This bubble peaked in mid-2006. At that time the average price of a house had reached over 4.5 times the average household income. By the spring of 2008 this had fallen to 4.0 times the average household income. Thus many economists argue that prices will continue to fall until the average house price is between 3.0 and 3.5 times average household income. This analysis is also widely accepted in Canada.
Thus, for example, the new row houses that were originally to be built as rental social housing, Maple Leaf Estates at 14th and Toronto, were instead put up for sale as “affordable housing” at a price of $169,000. By this calculation they should have been bought by families with at a minimum income of $56,000. Shelter costs also include property taxes, water and sewer, electricity and energy for heating.
House prices and inflation
A second approach used by economists measures the price of housing in relation to inflation. This is easy to calculate. Between 1996 and 2006 house prices in the United States rose by 70% above the general rate of inflation. It is argued that historically the price of housing did not rise faster than the general rate of inflation. There were ups and downs which went with the economy, but it averaged out.
Since the peak in housing prices in 2006, the average price of a house sold in the United States has fallen about 25%. According to this standard, the average price in the United States will have to fall another 40% - 45%. Currently, there is a growing stock of unsold houses. It is expected that around 3.6 million U.S. homeowners will receive foreclosure notices this year. In Chicago the resale of foreclosed houses has been at a discount of 40% to 60% from the original mortgage price.
Household net worth and annual income
Other economists have pointed to the supposed net worth of a household in relation to annual income. According to the U.S. Federal Reserve Bank’s Survey of Consumer Finances, in 2004 the average U.S. household had an estimated net worth of $448,000 and an average income of $43,000. The estimated wealth of the family was the equivalent of 10.4 years of income. But in 1989 it was only 7.3 years of income and in 1962 even lower at 3.8 years of income.
How could it be that household net worth had risen to ten times annual household income? The answer is leveraging. Going into debt. With easy borrowing available, through very unusual mortgages, people bought unnecessarily large houses in the suburbs. Others moved from rental units into “owning” their own home. A great many saw the assessed value of their homes go up rapidly and took out home equity loans to buy other assets. The average U.S. family acquired many credit cards and maxed them out. They bought expensive vehicles on credit. Total household debt increased from 50 percent of disposable income to over 100 percent by 2006. This house of cards has started to crumble. The 1962 ratio seems more realistic in this period of the great financial melt down.
The value of a house today
Given this reality, what is the real value of a house today? California has made the headlines due to the high rate of foreclosures. Most of this has occurred among middle and upper middle income families. In many areas of California the housing market has been dominated by the resale of foreclosed properties. Sales in these markets suggest that house prices will have to fall to 50 percent of their original purchase price. Economists call this “de-leveraging.”
The lesson is here for all to see. Be careful if you are looking to buy a house or taking out a home equity loan. As prominent U.S. economist Martin Feldstein warned a couple of weeks ago, there will be no end to the present U.S. recession until house prices have reached the bottom, which may be a few years down the road.
John W. Warnock is a Regina political economist and co-author with Della MacNeil of The Disappearance of Affordable Housing in Regina (2000).