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Short-run and long-run dynamics of home price tiers

Diego Escobari, University of Texas-Pan American, Damian S. Damianov, Durham University Business School

‘Boom and bust’ has become one of the catchphrases of the recent economic recession, capable of striking fear into the hearts of homeowners regardless of whether or not they have any deep understanding of economics. The trauma of the 2007-2008 housing bust is still fresh in the minds of many who found their homes underwater, or even lost them in the downward spiral of collapsing housing prices. The premise that homes are always a good investment, a quintessential dream for all, is shattered now. When young families want to climb or move up the property ladder, they ask now a lot more questions, but there aren’t always clear answers.

The housing market: the boom and the bust

Researchers from the University of Texas-Pan American and Durham University Business School compared the recent market boom and bust with previous run-ups and downturns in the housing market. While extant studies rely on a single measure to capture appreciation and depreciation rates, Escobari and Damianov, using US data, break down housing markets in price segments and study the differences in their dynamics. They analyze how the price tiers interact with one another, discovering new long-run trends and short-run effects. 

High tier versus low tier homes

While on the whole cheaper homes appreciated slightly more than expensive homes in the past three decades, cheaper homes were more susceptible to price fluctuations. Low tier homes appreciated faster during the market boom but lost more of their value during the bust of the market. Appreciation and depreciation rates across tiers however were much more similar during the bust than during the boom of the market.

Easy credit or market psychology

Perhaps counter-intuitively, price fluctuations is a matter that is – or ought to be – of particular interest to owners of lower-priced properties rather than those at the higher end of the market. The housing bubble showed an interesting characteristic in that cheaper homes experience both the sharpest rise in price at the beginning of the boom period and the steepest fall in price at its end. Researchers concur in attributing the occurrence of a bubble to the ready availability of cheap credit for first-time buyers. But have first time buyer been irrational or have they just been unlucky?

Dr Damianov and his co-author found a strong positive correlation between current appreciation rates of low tier homes and past appreciation rates of both high tier and low tier homes. That is, past price increases of the entire housing market could be viewed as a determinant of current price increases in low tier homes. This finding points to the existence of price momentum and provides some evidence of irrationality on the part of low tier investors. It has implication both for future first time buyers and for potential mortgage lenders when it comes to properties in the low segment of the market.