Monday, March 30, 2009

How Long Will the Downturn Last?

Of course there is no way to know for certain how long the current real estate downturn will last. Depending on who's opinion you read you may conclude that it will be over tomorrow or it will never end. The truth, no doubt, lies somewhere in between. I like to look at history for clues, and the saying goes, history does not repeat, but it often rhyms. So, several years ago, in anticipation of the coming real estate downturn, I did some research into what has happened in previous downturns. I used data from OFHEO (Office of Federal Housing Enterprise Oversight) and looked at every housing downturn that has happened since they started keeping records in 1975. I graphed the results below. (Please click on the chart to see the whole thing)

As you can see, there have been about a dozen localized real estate busts in the last 35 years prior to the current national bust. In all but a few cases, real estate prices regained previous peaks within about 8 years, the biggest outlier being Houston, which didn't regain its previous peak for almost 15 years after the bursting of the oil-embargo fueled bubble in Houston's oil revenue dependant local economy.

Another thing to remember is that these are nominal prices. Homes were overpriced in most of these markets at previous peaks and so on an inflation adjusted basis most didn't regain previous inflation adjusted peaks until the recent housing bubble caused them to become overpriced once again. Houston has never fully recovered on an inflation adjusted basis.

What does this tell us about the current real estate downturn? I think it tells us not to expect to see 2005 prices again for at least 5 years, which would be 8 years from the peak here in San Diego. I would bet, given the magnitude of the bubble that occured, it may take somewhat longer than average this time around as well. However, another conclusion can be drawn. Looking at any one of the most severe downturns, similar to the current downturn, if you bought a property anywhere near the bottom and held it for 5-8 years, you would have made a very good return on your investment. Even in Houston, which was the slowest to recover, prices appreciated about 23% in the first 5 years of the recovery. If you were able to purchase with 50% down, that would have been a 46% gain on your investment, in addition to the cash flow being collected from rents.

The difficult part, of course, is finding the bottom. In my previous entry, I explained why I think the bottom is at hand in certain segments, but not in others.


  1. I like your postings. I came across your blog today after reading your posting on the article "Home Prices: Low, But Still No Bargain". Making good use of your CFA education I see. Question though, what does your chart look like if you use CSW data rather than OFHEO (which only tracks Fannie/Freddie loans)?

  2. That is a good question. Unfortunately the Case Schiller indexes only cover 20 cities, excluding Austin, Houston, Honolulu and Sacremento. Thier data also doesn't go back far enough for the Dallas, Las Vegas and Portland downturns. Out of the 5 downturns their data does incorporate, the timing of the peaks and recoveries were slightly different resulting in the recovery taking about six months longer in Boston and Los Angeles, a year longer in NYC, unchanged in San Diego and a few months shorter in San Francisco when compared with the OFHEO data.