Jun 21, 2008
Wharton professor Todd Sinai on the credit crisis and home values
21 Jun 2008
Posted by VAR
Wharton Business School’s blog this week features an interesting conversation with Professor Todd Sinai on home values, how housing should be looked at differently than stock investments, and the factors that have led to the current price declines many markets are seeing nationwide.
Here’s an excerpt:
Knowledge@Wharton: Homes have long been thought of as a rock-solid investment, the thing that always gained value and never let you down. And now, in the last decade or so, a lot of people seem to have started to look at their homes as investments — and not just speculators, but ordinary people who thought there was a huge value that they could tap in their homes. And we’ve seen that now they’re behaving like investments, like stocks, which sometimes go down and don’t always go up. Has the real estate market evolved or changed, or is this just part of a regular cycle that we see from time to time?
Sinai: Wow, you’re starting with a doozy of a question. There are a lot of answers to that. So, to take the last part first, the real estate has changed, but still, there’s a lot that is the same. So let’s start with the fact that you started with, that house values are behaving like stocks now, and they didn’t behave like stocks before, that they’re exhibiting more volatility now than they used to. I don’t think that’s really quite true.
So, what we’re seeing now that we haven’t seen in the past is actual declines in house prices — nominal house prices at the national level. We’ve seen actual declines in house prices at the local level before. If you owned a house in Boston that you bought in 1988, by 1992 you were underwater on your mortgage, even though you had put 20% down. So house prices have fallen before. The thing that they’ve done at the national level is they’ve fallen in real terms, and they’ve always gone up in nominal terms.
Well, back in the 1970s, and even the 1980s, when we had lots of inflation, it was easy for house prices to go up a lot in nominal terms but still be losing real money in real terms.
Knowledge@Wharton: In other words, the price went up, but when you factor in inflation, this is where you’re really losing value.
Sinai: Absolutely. So, comparing your house price to nothing happening, to keeping money under your mattress, is probably the wrong thing to do. Comparing it to what you could have made in some other investment is probably the right thing to do. And housing has dropped a lot in the past. So it’s evolved to a kind of asset.
Now, having said that, to think of houses as an investment, I think is somewhat different. And, I think it’s partly because, for people who are living in their house — it’s being used as a primary residence — there’s not a lot of investment value to it.
And what I mean by that is that I bought a condo in mid-town Manhattan. Let’s say I paid $500,000 for it in the mid-1990s, and it’s worth $1.5 million now. Well, if I sell that and I still want to live in mid-town Manhattan, I’m still out a million-five to buy another one. So, my investment has gone up a lot, but it just covers what I need to buy with it, which is a place to live.
And the difference between housing and the stock market is that when you sell the share of stock and it’s doubled in value or tripled in value, you can buy more stuff. If your house doubles or triples in value, you can buy the same amount of housing — unless you’re going to move somewhere else where houses’ prices didn’t rise quite as much.
So it’s a very different thing to think about in terms of an investment. And I think when people say that people are using it as an investment, what they mean is they’re using it as a line of credit.