The Cure For Low Home Prices -- Another Sign Of A Turn

(MoneyWatch)  Today the astute economists at Northern Trust in Chicago call to our attention another data point suggesting, as we noted last week, that home prices may be bottoming: a large drop in their "home price-to-rent ratio," which compares the rise in purchase prices to changes in rents, a sort of price-earnings ratio for houses.

The idea behind the ratio makes a lot of sense -- it compares the amount a short-term renter will pay to use a house one year at a time to what an investor owner thinks it will be worth over the long haul. The ratio increases when the perceived value of owning goes up faster than the value of renting -- as it did during the recent bubble. The average value of the index since 1987 has been about 100; during the 1990s it sagged a little, to about 90, but after 2000 surged up to 160. It's been dropping sharply since 2006, back to the neighborhood of 100. (See chart at right; click for a larger version.)

Here is an excerpt of economist Asha Bangalore's daily comment from April 6:

At the end of 2008, the price-to-rent ratio showed a noticeable improvement, with the ratio in the fourth quarter of 2008 closer to the long-term average. The fourth quarter price-to-rent ratio is well within the range of the mean of the entire 20-year historical period, which includes the go-go years of 2001-2008.

The main take-away is that home prices are most likely to decline in the months ahead, given the elevated level of inventories [currently about nine months' worth of sales]; but the pace of decline will be assuredly small.

By comparing the market for rentals to the home purchase market, this ratio incorporates a lot of information -- the decisions of two different types of consumers -- and thus is more meaningful than just looking at home prices alone and concluding "prices are up 30 percent -- that's too much (or too little)." The return to earth of the home price-to-rent ratio could be another signal of a turn in housing.