From the WSJ:
Only a year and a half ago, none other than Warren Buffett told CNBC he would invest in “a couple hundred thousand” single-family homes if it were practical.
But in that short period, the national housing market has gone from the cheapest it has been in a quarter-century to slightly overpriced—at least according to some measures.
Relatively cheap mortgages still make it a great time to buy a home to live in, but anyone hoping to treat it as an “investment” should be wary.
In early 2012, homes did indeed look inexpensive. To measure home values, some researchers divide home prices by rents. The resulting price/rent ratio is similar to the price/earnings ratio commonly used to evaluate stocks.
By that measure, in the fourth quarter of 2011—when the ratio was 19.9—homes were the cheapest they had been since 1987, according to data from Morris Davis, academic director of the James A. Graaskamp Center for Real Estate at the University of Wisconsin.
Since then, though, the housing narrative has done an about-face. Money managers have launched private-equity funds and real-estate investment trusts designed to scoop up homes and rent them out, and real-estate agents once again tell of bidding wars for homes in some areas.
In all, between May 2012 and May 2013, the latest month for which data are available, the S&P/Case-Shiller 20-city index of home values climbed 12%. Home prices in two of the index’s metro areas—Denver and Dallas, which missed much of the boom—hit all-time records.
Instead of signaling a bargain, the national price/rent ratio in June was at 22.8—already above the historic long-term average of 20.6.
That isn’t to say home prices will start dropping again. Even more so than the stock market, the housing market is a slave to momentum. Prices get out of whack but continue to spiral upward as stories of double-digit gains spread from owner to owner. The last bubble, for example, took many years to inflate before popping.
But for value-seeking investors, the recent brief era of cheap prices is over.
Since 1960, home prices have increased only by about 1.3% annually after inflation, according to Mr. Davis. He says that the current price/rent ratio suggests home prices will increase more slowly than rents over the next five to 10 years.
Based on different data, other researchers have found home prices over long periods merely keep up with inflation.
Other ways of valuing homes are slightly more optimistic but still don’t call for a continuation of last year’s boom.
Instead of comparing prices to rents, some economists prefer to compare prices to average household income for a quick measure of homes’ affordability.
Right now, that ratio stands at about 1.78, according to Moody’s Analytics, compared with 1.92 between 1989 and 2003, before the housing boom started. To get back to average, home prices would have to rise another 8% if incomes stayed constant, says Moody’s Analytics economist Greg Bird.
A significant drop in prices is unlikely, says David Blitzer, managing director at S&P Dow Jones Indices, who also tracks the housing market.
“Mortgage rates, even though they’ve popped up a bit, are still close to as low as we’ve ever seen,” he says. “If you’ve been thinking of buying a house, you better get out and do it.”