Evaluating housing on a relative-yield basis

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This post is a guest contribution by Paul Kasriel* of The Northern Trust Company.

In terms of the level of mortgage rates, the sale price of houses and the income of families, the affordability of home purchase of late is higher than it has been in about 40 years (see Chart 1).

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With Thursday’s release of flow-of-funds data by the Fed, I can demonstrate yet another factor suggesting the current attractiveness of a home purchase – the implicit yield on owner-occupied housing in relation to the cost of financing a house purchase.

I calculate the implicit yield on owner-occupied housing by dividing the “space rent on stationary owner-occupied housing” (from unpublished GDP data pertaining to personal consumption expenditures) into the market value of household real estate (from the household balance sheet data in the Fed’s flow-of-funds accounts). Then I compare this implicit yield on owner-occupied housing with the level of mortgage rates pertaining to the sales of existing single-family homes. Chart 2 shows a history of this calculated implicit yield on housing and the financing or mortgage rate.

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In the first quarter of 2009, the implicit yield on owner-occupied housing was 6.02%; the contract mortgage rate was 5.07%. The data in Chart 2 show that it is rare for the implicit yield on housing to be above the cost of financing a house. In fact, from the late 1960s until now, the implicit yield on housing has always been below the mortgage rate.

Of course, the factor that has driven up the implicit yield on houses has been the recent extraordinary decline in real estate values rather than an extraordinary increase in “space rent” on owner-occupied housing (see Chart 3). This is not to say that the implicit yield on housing will not move higher over the remainder of this year, especially if residential real estate values continue to fall, as I expect they will over the rest of this year. But mortgage rates already have moved higher in recent weeks. In sum, the higher relative implicit yield on owner-occupied housing is yet one more positive element arguing in favor of the bottoming of housing demand.

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Source: Paul Kasriel, Northern Trust – Daily Global Commentary, June 12, 2009.

*Paul Kasriel is Senior Vice President and Director of Economic Research at The Northern Trust Company. The accuracy of the Economic Research Department’s forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul’s 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst.

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