Monday, September 25, 2006

How can you tell if your house will lose value?

Kevin Hassett has a good piece on the housing market here. He is attempting to offer guidance as to whether there is "arbitrage" opportunities to move out of your home and buy it back after the housing market goes "poof."

He makes the following two criticisms of such a move.

1) Transaction costs are high. You have to higher a broker, put your home on the market and basically hope someone is dopey enough to buy it at its 3 year high. Then you have to buy it back--probably from the same person--when the market bottoms out. Hmmmm.

2) Then we have to consider whether prices are going to decline in the first place. He gives some useful guide posts, all of which are based on supply and demand.

a) Look for an increase in supply (an increase in supply lowers price and increases output). If a bunch of McMansions popped up in your town recently, be wary.

b) Take a look at inventories. If a lot of homes are on the market but are not selling (i.e. those real estate stickers on the lawn), that suggests there is a supply and demand imbalance. That is, the quantity supplied is in excess of the quantity demand. In order to correct, prices have the fall and the quantity supplied has to decline.

A caveat: The housing market is peculiar in that it is not liquid. People don't flip their homes left and right, despite the recent demand for investment homes in recent years. Therefore, in anticipation of a price decline, home owners may just decide to sit this one out for a few years and wait to move into a bigger McMansion. Whether this move will be enough to prevent prices declining is something we are, unfortunately, going to have to wait for in upcoming data. The increase in home purchases purely for investment purchases means that some people may have purchased a home they are not living in. They do not face the same contraint in selling the home(since they live somewhere else), but they will be concerned whether they make a profit (hence getting rid of it now in order to make sure them come on top). The main question is: how many are in each camp?

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