March 31, 2011
A headline at CNN’s money page caught my eye recently: “Why house prices will keep falling.”
The article cited the Case-Shiller U.S. House Price Index, which showed a 3.1 percent decline from January 2010 to January 2011. The gist of the index, developed by Karl Case and Robert Shiller, is that home prices tend to follow inflation.
On the surface, that seems obvious. Inflation, which probably should be called price inflation, is just that—increases in prices relative to the value of the dollar. Most prices, including prices paid for homes, increase steadily over time, and economists use these increases to calculate inflation. Economists often separate food and fuel because they are volatile, leaving core inflation, which tends to be steady. Case and Shiller did something different. Instead of pulling out fuel and food, they separated house prices. According to their research, home prices generally follow inflation. The key is that they generally follow inflation; when home prices diverge from core inflation, Case and Shiller expect them to later realign. If home prices rise faster than other prices, home prices later fall.
It doesn’t take more than a glance at a graph of their latest data to see that real estate prices grew quite a bit faster than inflation during the 2000s. The graph is an index, so it uses a baseline price and a base year (100 is the price, 1980 is the year). Core inflation is around 220 now, meaning that a good or service that cost $100 in 1980 costs $220 these days. The housing index is based on the 1982-1984 timeframe and is around 340 now. From 1987 to 1997, the housing index was about 40 points higher than the core index, which suggests that house prices have a long way to fall until they are back in line with core inflation. Case was quoted as saying that home prices might fall another 25 percent.
If you follow a lot of economic data, you’re probably wondering what it all means. The National Bureau of Economic Research says that the recession ended in June 2009, but unemployment is still at 8.9 percent (that’s Bureau of Labor Statistics data), yet according to Case and Shiller, home prices are still falling. What’s going on here? Has the recession ended or hasn’t it?
And that’s exactly my point. The recession isn’t going to end all at once. The economy is growing slowly, and each sector is going to recover at its own pace. The key is finding some factors to track that have relevance to you and your business.
Home price data is a good one for many fabricators to watch, and here’s why. Most people spend more than a few dollars on appliances, a lawn mower, and a few other goodies after purchasing a home, whether or not the home is new. An increase in home construction is an especially good sign because a new home must have quite a few fabricated products—appliances for the kitchen and laundry, and also the furnace and the air conditioner. This is where the Case-Shiller index comes into play. New-home construction is falling these days, and it won’t level out until home prices stabilize. Why would a prospective homeowner build when he could buy a bargain?