The Housing Hockey Stick Redux

During most of the last century, the Shiller Real Home Price Index was remarkably flat before surging into a dramatic hockey stick in the early 2000s. After the bubble burst, the index plunged and recently touched a new cycle low. Some experts argue that the index will revert to its long-term average and that home prices need to drop another 25%.

But investors should be aware that the Shiller Index itself is stitched together from several different sources; the data that is currently collected doesn’t really have a historical mean to revert to. Other data, meanwhile, suggests the worst of the bust is done.

To create a long-term real home price index (the long thick line in the chart) Yale economist Robert Shiller collected historical data back to the 1880s. As Shiller explains, the earliest segments in the index are based on surveys and newspaper ads, when hard data was scarce. Then in the 1950s the government began compiling a number of formal house price indexes, two of which are used in Shiller’s index. The Case-Shiller Home Price Index (which Robert Shiller co-created with Karl Case) takes over in 1987. The boom and bust in the overall index, therefore, is reflecting the swings in the short history of this last segment.

The apparent stability of the distant past might look different if a consistent data set were available. The Case-Shiller segment (the thin dark blue line) surged 85% during the boom and then plunged 34% during the bust. The preceding segment of the index uses data from the FHFA, formerly OFHEO (the orange line); it surged 50% during the boom and then plunged 23% during the bust. Another source altogether that is compiled by the US Census Bureau, the Quality-Adjusted New House Price Index (the green line), isolates the underlying new home price trends from quality improvements by explicitly adjusting for size, amenities, and location; it surged 25%, plunged 20%, and is now back to where it was.

Mean reversion, however, isn’t always a sure thing. During an earlier hockey stick in the late 1940s, the Shiller Real Home Price Index surged 60% and stayed there. Indeed, the index shows three distinct periods of sustained equilibrium: it held steady in its first few decades into the 1910s, dipped down to a lower level in the 1920s through World War II, then popped in the post-war surge to a higher level, holding steady for several decades until the hockey stick of the 2000s. Today’s home prices could settle into any one of those equilibrium levels … or perhaps a new and higher equilibrium altogether.

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