May 26, 2006

Reversion to Mean for Bay Area House Prices?

charles hugh smith-After the Bubble: How Low Will It Go? 


This chart provides a very clear picture of what a bubble looks like: a slow rise in values which suddenly turns up in a hockey-stick ascent to unsustainability. Note that the decade between 1986 and 1997 ended with housing values a bit above the historic line, but not by much. During all those years of flat-to-modest appreciation, the population was also growing, they weren’t making any new land, etc. etc.–all the conditions were present which are trotted out to justify the bubble. Note that the hockey-stick rise began as the Nasdaq bubble created hundreds of billions in new wealth in the late 90s.

Let’s go over the numbers. According to the Bureau of Labor Statistics, $100 in 1986 equals $178 in today’s (devalued) money. To that 78% rise due to inflation we add Shiller’s 1% per year appreciation in “real” terms, which adds up to a historically supported value 98% above the 1986 median price of $161,000. In other words, a reversion to the historic mean will bring Bay Area median prices down from $715,000 to around $315,000–a decline of $400,000.

This is the inescapable conclusion of Shiller’s analysis and historical trends dating back to the 19th century. It cannot be denied; but you can of course retreat into denial. Sadly, that’s what most investors did back in the dot-com heyday. As stocks tumbled, every brief uptick was embraced as the “bounce back” to the good old days, and every such bounce was a sucker’s rally, leading only to further precipitous declines.

Fortunately, as we all know, this is impossible.

Click here to post a comment -- Posted by: burbed @ 5:00 am

No Responses to “Reversion to Mean for Bay Area House Prices?”

  1. albert Says:

    I think there’s a basic math error in a calculation on that graph. It says that 20 years of 1% appreciation result in a 20% increase in home prices.

    That’s not how it works.

    You need to take 1.01 and raise it to the 20th power, which means that an annual 1% rate of appreciation results in asset prices about 22% higher over 20 years.

  2. burbed Says:

    I think you’re right… something is a bit strange…

  3. One FukkaModa Says:

    Are you guys kidding?

    If you are not bullish yet on the SF Bay Area, then there is no hope for you my little pundits.

    Bay Area real estate will be Class A from now until the earth is extinct….. Go travel to some new lands and then you will learn quality.

    BGiotch


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