Shiller: Real estate is risky business
Economist Robert Shiller points to several indicators that suggest prices are out of whack.
By Les Christie, staff writer

NEW YORK ( - Though U.S home-price gains have slowed, prices still far outstrip fundamentals, according to Yale economist Robert Shiller.

Speaking Friday at a press conference in New York, Shiller, the author of "Irrational Exhuberance" and co-producer of the Case-Shiller real estate indexes, pointed to several measures he tracks.

Latest home prices

In justifying his pessimism, he pointed out that price increases have far out paced rises in construction costs, rents and income. In addition, inventory levels are up, as are interest rates and real estate holdings as a percentage of the gross national product.

All these metrics would indicate that prices are way overblown and due to slow. But that has not happend on a wide scale, though there has been recent weakness in some markets, including Boston and San Diego.

"Home prices lately have done something really remarkable," said Shiller. "This is the biggest boom the United States has ever seen."

The only other market the current one can be compared with, according to Shiller, is the boom following World War II when returning veterans got married, started families and bought homes. But that was a much more fundamental event, one driven by strong demand.

This latest one, says Shiller, is a speculative boom. "It's an uncertain situation," he says. "It looks like a down cycle that might continue down or it may bounce around. I will not make a forecast but this pattern suggests risk."

Shiller has recently participated in the launch of investment products for those who want to bet on real estate's direction. Those products, S&P CME Housing Futures and Options, are based on the Case-Shiller indexes. These derivatives enable hedgers to take a position on the direction of home prices either for the nation as a whole or for 10 major cities, including New York, Los Angeles and Chicago. They began trading May 22.

Shiller points out, though, that to trade these derivatives, there must be investors on both sides of the deal: ones that believe prices will rise and others speculating that they'll fall. It's not in his interest to promote either scenario.

Crucial construction indicators

In his talk, Shiller focused on new home construction. In his view, high home prices explain record residential construction. Building has continued, almost unchecked, until very recently, even as new home inventory has nearly doubled in the past few years. With home prices still so much higher than building costs, the profits were so high that developers kept building.

"You might worry," he said, "that construction will continue until prices come down."

When, in the past few months, new home construction took a slight dip, Shiller saw that as a sign. "Builders are seeing a whiff of the end of the boom and are not taking on as many permits," he said.

Will markets actually fall? Nobody knows. Shiller says that, long term and adjusted for inflation, home prices bounce up and down but essentially stay flat over the decades. If that is the case, than the out-sized returns of the past few years would argue that, to catch up with the runaway markets, prices would have to at least stabilize for a few years, even if they don't actually fall.


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