by Calculated Risk on 4/26/2011 11:08:00 AM

First, here is a graph showing nominal house prices for three indexes:

Nominal House Prices

Click on graph for larger image in graph gallery.

The first graph shows the quarterly Case-Shiller National Index (through Q4 2010), and the monthly Case-Shiller Composite 20 and CoreLogic House Price Indexes (both through February release) in nominal terms (as reported).

In nominal terms, the National index is back to Q1 2003 levels, the Composite 20 index is 0.4% above the May 2009 low, and the CoreLogic index is back to January 2003 levels.

Once the Case-Shiller Composite 20 falls below the May 2009 low, the index will be back to early 2003 levels.

Nominal prices will probably fall some more, and my forecast is for a decline of 5% to 10% from the October 2010 levels for the national price indexes.

Real House Prices

The second graph shows the same three indexes in real terms (adjusted for inflation using CPI less Shelter).

Note: some people use other inflation measures to adjust for real prices.

In real terms, the National index is back to Q1 2000 levels, the Composite 20 index is back to November 2000, and the CoreLogic index back to January 2000.

A few key points:
• In real terms, all appreciation in the last decade is gone.

• I don't expect national real prices to fall to '98 levels. In many areas - if the population is increasing - house prices increase slightly faster than inflation over time, so there is an upward slope for real prices.

• Real prices are still too high, but they are much closer to the eventual bottom than the top in 2005. This isn't like in 2005 when prices were way out of the normal range.

Price-to-Rent

In October 2004, Fed economist John Krainer and researcher Chishen Wei wrote a Fed letter on price to rent ratios: House Prices and Fundamental Value. Kainer and Wei presented a price-to-rent ratio using the OFHEO house price index and the Owners' Equivalent Rent (OER) from the BLS.

Here is a similar graph through January 2011 using the Case-Shiller Composite 20 and CoreLogic House Price Index.

This graph shows the price to rent ratio (January 1998 = 1.0).

On a price-to-rent basis, the Composite 20 index is just above the May 2009 levels, and the CoreLogic index is back to January 2000.

An interesting point: the measure of Owners' Equivalent Rent (OER) is at about the same level as two years ago - so the price-to-rent ratio has mostly followed changes in nominal house prices since then. Rents are starting to increase again, and OER will probably increase in 2011 - lowering the price-to-rent ratio.

This ratio could decline another 10%, and possibly more if prices overshoot to the downside. The decline in the ratio will probably be a combination of falling house prices and increasing rents.

Earlier:
• Case Shiller: Home Prices near post-bubble lows in February