Trulia’s Ralph McLaughlin and Wharton’s Benjamin Keys discuss the housing market recovery.

It has been almost 10 years since the last big bubble in the U.S. housing market began to pop — the leadoff to what became the Financial Crisis and the Great Recession. In many respects, the U.S. economy has rebounded nicely from that disaster: Broadly speaking, stock indexes are setting record highs, unemployment is back in check, and consumer confidence has returned.

The question of whether the housing market has genuinely recovered, though, is more complex. A recent report complied by real estate website Trulia reveals a wildly uneven housing recovery, in which some parts of the country are seeing prices for nearly all homes above their earlier peaks, while in other areas, most homes are still far below those levels. Nationwide, just over a third of homes have reached pre-recession prices, and the forecast is that pricing won’t fully recover until 2025. Trulia chief economist Ralph McLaughlin and Wharton real estate professor Benjamin Keys, who is also a faculty research fellow at the National Bureau of Economic Research, recently visited Knowledge@Wharton’s SiriusXM show to discuss the housing recovery.

Housing Market
Photo by midiman

An edited transcript of the conversation follows.

Knowledge@Wharton: Ralph, please go through the report and really break this down as to what we’re seeing, and how far we are from getting back to full pricing on a lot of these homes across the U.S.

Ralph McLaughlin: The highlight of the report is that only a little over a third of homes in the U.S. have recovered to their pre-recession peak values. But that distribution varies pretty widely across space. For example, in places like Denver and San Francisco, nearly 100% of homes have recovered, whereas in areas such as Las Vegas, Tucson or Bakersfield, fewer than 3% of homes have recovered. The secondary takeaway … is that income growth is perhaps one of the biggest differentiators that explains why some places have recovered and others haven’t. A few other factors that are correlated include things like population growth and job growth.

As far as predicting when the housing market will fully recover, if you use our measure of recovery, from a linear perspective it might not be until 2025. But the housing market, as you both know, can take sharp swings upward or downwards, so that could be either sooner than 2025 or much later.

Knowledge@Wharton: What was your reaction to this report, Ben?

Benjamin Keys: The economist in me first wondered if these were in nominal dollars or real dollars; people have this very artificial sense of a nominal value in the housing market. There’s been a lot of really nice research that has shown people are very sensitive to loss aversion. If I buy a house for $200,000, I’m really reluctant to sell it for even a dollar less. Those losses feel much more painful to me than the similar gains would feel in terms of making me feel better.

So there’s an artificialness to this as a benchmark, but I’m thinking of this as something that’s going to resonate in a lot of people’s minds who bought in 2005, 2006 or 2007 at very high prices. But whether these kinds of trends are going to persist, and whether we’re going to see this recovery reach these other markets, I think that’s a much deeper and really important question. The markets that have been left out of the house price recovery are some of the ones that had the most inflated and exaggerated bubbles, where we had the worst behavior in terms of mortgage market discipline, where we had the most teaser-rate contracts and low-documentation loans.

You look at Las Vegas, where almost none of the houses are back to their peak levels, and you really begin to appreciate just what distortions were going on in the market at that time, and how long-lived the recovery has to be to get the market back to a place that looks like it did prior to that bubble period.

Knowledge@Wharton: Ralph, Ben mentions Las Vegas, and it’s a well-documented story about how much trouble that metropolitan area had in terms of the drops in price. You have a list of the top 10 cities that have not recovered to this point, and what I found interesting was there were a couple of markets in there that are, for the most part, considered to be more lower-income cities — Camden, New Jersey, across the river from us here in Philadelphia, being one of them. Those are cities that obviously lost a good bit after the housing bubble burst and the recession hit. The question is whether or not they can regain it to any degree when you think long term.

“Just because your housing market hasn’t recovered to its pre-recession peak doesn’t necessarily mean it’s a bad thing.” –Ralph McLaughlin

McLaughlin: There are a couple of interesting points that Ben brought up that relate to this that are important to dive into a little bit more. One, is the pre-recession peak an acceptable benchmark given how inflated some of these markets were? Our measures are nominal, which is the point that Ben makes. We chose to use nominal values because we think that for most homeowners, that’s their benchmark. Most homeowners are not adjusting for inflation in their head, and so it affects the psychology of the market. From a nominal perspective, yes, these markets eventually will recover, at the least just because of inflation.

Second is whether or not really they’re going to recover from an inflation-adjusted standpoint. For some of these markets, if they do, it may be decades — and in particular when you’re talking specifically about the markets that tend to be in the Rust Belt — places like New Haven, Connecticut; Lake County, Illinois/Kenosha, Wisconsin; and Camden, New Jersey — those areas are seeing pretty long-term and significant population declines, which are never highly correlated with increases in prices. Usually, population decline leads to decreases in prices.

Now, some of the other markets, in particular, those in the West that may either be fast growing or near markets that are fast growing — think Las Vegas, or in California, Bakersfield, Riverside, and San Bernardino — those markets are probably going to recover, in my expectation, faster than some of those Rust Belt markets.

Keys: Absolutely. I think one of the things that this highlights is the real divergence across cities in the U.S. That’s something that we’ve seen in the income distribution, and something that we’re seeing across cities as well; there’s a set of stagnant cities that are really struggling, and with housing being such a durable good, it’s very difficult to adjust a city’s footprint or the number of houses that are available. We know that places that have a sizable downturn can be trapped in that state for a very long time, and there aren’t a lot of easy ways to pull out of it. It takes a really active local government and local public policies to turn things around.

Knowledge@Wharton: Ralph, when you bring these numbers forward to people, is there a level of surprise

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