Real scoop on local home prices

The downward trend in U.S. home values continues to make news.

The widely watched S&P/Case-Shiller Home Price Indices released Tuesday indicated a record 15.4 percent decline in U.S. home prices the second quarter of 2008 versus the second quarter of 2007.

For Charlotte, home values declined 1 percent in June 2008 relative to June 2007, a minuscule drop when compared to the over 20 percent declines in markets such as California.

In fact, the slight year-on-year decline in Charlotte home values in June (and in May) mask recent movements that instead indicate positive momentum: after falling continuously from their peak in August 2007, Charlotte home values have ticked upward about 0.4 percent per month on average every month since February.

If this trend continues, the year-on-year change in Charlotte home values will again turn positive by September. But while Charlotte area home values are rising, one factor often overlooked is that, like any real asset, changing home values reflect the forces of supply and demand, and inflation.

That is, one normally expects home values to rise at least at the rate of inflation, with any additional increase (or decrease) reflecting movements in the underlying real supply and demand of houses.

To separate these two sources of change in home values, one can adjust the change in home values for inflation. Using the S&P/Case-Shiller Home Price Index for Charlotte, Chart 1 shows the movements since January 2000 in the nominal and real values of Charlotte area homes.

The inflation adjustment uses the Bureau of Labor's consumer price index for all urban consumers living in the South in cities with populations between 50,000 and 1.5 million. As shown in the accompanying chart, the nominal value of Charlotte area homes grew steadily but at a modest average annual rate of about 2.6 percent from January 2000 to about March 2005.

This nominal increase was in line with the general rate of inflation over the same period, meaning that inflation-adjusted or “real” home values were relatively flat.

However, after March 2005, home values took on a new trajectory, with values rising at an average annual rate of about 6.6 percent. Since this rate was well above the rate of inflation, real home prices also rose substantially.

In August 2007, home values peaked and thereafter ticked down each month until the recent up-ticks starting from March 2008. However, with inflation edging upwards in recent months, rising home values have not kept pace with inflation.

As shown in the chart, real home prices continue to fall from their peak in August 2007. If the current trends in home values and rate of inflation continue, the data suggest that real home values will return to their pre-March 2005 average level around May or June of 2009. After that, whether nominal home prices follow the rate of inflation and hence stabilize, or continue to fall in real terms is anyone's guess. But don't get fooled into thinking that the recent rise in home values is a real increase.