A Report on Palm Beach County, Florida's Housing Market: January 2019
Housing cycles are now a persistent challenge for markets across the country. Real estate values no longer rise in a steady and consistent trend. Unfortunately, prices now tend to trend noticeably above or below a local long-term linear pricing trend.[i]
This cycling in prices creates a new level of risk in homeownership. Real estate consumers now need to consider where their local market is positioned in its current real estate cycle. They must constantly be evaluating the degree of local over/under pricing as well as looking for evidence of downward/upward pressure on the demand for homeownership. Clearly, real estate consumers do not want to purchase at the top of a cycle signaled by rising prices and downward pressure on the demand for homeownership. Alternatively, property purchases are most desired at the bottom of a cycle signaled by falling prices and upward pressure on the demand for homeownership.[ii]
This report investigates where Palm Beach County, Florida is positioned in its current housing cycle. Specifically, this report investigates: (a) the current degree of overpricing in local housing and (b) the amount of downward pressure on the local demand for homeownership. Findings indicate that housing in Palm Beach County is currently 19.76% above its long-term linear pricing trend and that the county is presently exhibiting downward pressure on the demand for homeownership with a Beracha, Hardin and Johnson Buy versus Rent Index (BH&J Index) score of .28.
Repeat Sales Indices (Pricing Trends)
A repeat sales index models the trend in housing prices based on local transactions. Embedded in the BH&J Index for metro Miami is a repeat sales index provided by the Federal Housing Finance Agency (FHFA).[iii] Historical values can be employed to estimate property appreciation (and therefore prices) through time. Figure 1 provides the depiction of property prices in Palm Beach County from 1977 through today. Figure 1 also provides the long-term linear pricing trend in prices based on each quarter’s scores.
Based on where prices should be at this point in time (which is taken from the long-term linear pricing trend) and where they are currently located indicated by the current repeat sales index score, we can estimate that property prices in Palm Beach County are currently 19.76% above the area’s long-term linear property pricing trend.
While this number should be alarming, it is important to compare the current degree of overpricing with that of the last cycle’s peak. Specifically, at the peak of the county’s last real estate cycle, property was, on average, 66.27% above its long-term linear pricing trend. Thus, while Palm Beach County housing is currently over-priced, property is not as dramatically overpriced as it was at the peak of the last cycle.
BH&J Index (Pressure on Demand for Homeownership)
The BH&J Index is an open source real estate market sensor that is freely available to consumers. The index is a “horserace” between homeownership with equity buildup and renting a comparable property while reinvesting rent differentials (the difference between the cost of homeownership and the cost of renting) in a portfolio of stocks and bonds. The simple question is which strategy creates more wealth. Beracha and Johnson (2012) outlines the methodology for producing the index.[iv]
By default, BH&J is an equilibrium model between renting and owning. Thus, the index scores provide evidence of pressure on the demand for homeownership. The index is standardized with scores ranging between +1 and -1. Scores approaching +1 indicate extreme downward pressure on the demand for homeownership. Typically, pricing downturns follow historically high BH&J scores. Index scores approaching -1 suggest significant upward pressure on the demand for homeownership. Typically, pricing upturns follow historically low BH&J scores. Scores hovering near zero tend to indicate minimal to no abnormal pressure on the demand for homeownership.
Palm Beach County property transactions are embedded in the metro Miami BH&J Index, which is used here to estimate the pressure on the demand for homeownership in the county. Currently, the area has a BH&J score of .28. This score, like the area’s degree of overpricing, should draw the attention of potential purchasers in the county as it indicates moderate downward pressure on the demand for homeownership. By way of comparison, the area’s BH&J score at the peak of the last cycle was 1.00. Figure 2 provides a look at BH&J scores for the area from 1982 through today.
Clearly, BH&J scores have been increasing in recent quarters suggesting a decline in the demand for homeownership for the area as the financial benefits from renting and reinvesting slowly begin to outpace the benefits from owning and building equity.
When comparing Figures 1 and 2, it appears that the combination of increasing property prices and increasing BH&J scores signal a cycle’s peak. The opposite is true for cycle bottoms where decreasing property prices accompanied by decreasing BH&J scores signal the lower end of a housing cycle.
Where are we now?
The phenomenon of extreme housing cycles is relatively new, making it difficult to predict what comes next for the county. However, it is safe to say that property purchases now will be, on average, above the long-term linear pricing trend. Said another way, a “good deal” in financial terms will be very difficult to come by. Accordingly, all potential purchasers in the area are advised to negotiate aggressively.
What is going to happen in terms of pricing? This is even more difficult to determine. Currently and relative to the last cycle’s peak, housing in the county is only moderately overpriced and is accompanied by only moderate downward pressure on the demand for homeownership. Thus, it is possible that the coming real estate downturn will not produce significant property price declines, but instead generate a period of flat property prices and extended marketing efforts.
A couple of caveats, however, are worth noting. First, not all markets around the country are at the same levels of overpricing and BH&J scores. Some markets are exhibiting extremely high levels of overpricing and high BH&J scores. Thus, the outcomes in these markets might well be different, leaving the open question of contagion between markets such as Dallas, Denver, and Houston and other more stable markets around the country.
Second, the degree of overpricing at a cycle’s peak dictates the severity of the housing downturn. Shallow peaks result in minimal downside effects. Alternatively, extreme peak overpricing most often results in a market crash, as witnessed in the last housing cycle for the area.[v] Thus, while prices are only moderately overpriced at present, the continuation of rapid property appreciation in the area could lead to another market failure.
Beracha, Eli and Ken H. Johnson, Lessons from Over 30 Years of Buy versus Rent Decisions: Is the American Dream Always Wise? Real Estate Economics, 2102, Vol 40:2, pages 217 – 247.
[i] For the last 50 years, housing prices have fluctuated around a long-term linear trend. However, this variability has been minimal until recent years when swings around the trend have become dramatic.
[ii] Housing prices have historically exhibited momentum, thus it is possible for prices, in the short-term, to continue to rise in the face of downward pressure on the demand schedule for homeownership. The opposite is true for falling prices and upward pressure on the demand for homeownership.
[iii] The FHFA All Transactions Quarterly dataset is employed to develop the repeat sales index for Palm Beach County.
[iv] The BH&J Index scores provide two pieces of information: (1) is it better, on average, to rent and reinvest or own and build equity in a given market and (2) the level of pressure on the demand for homeownership.
[v] Robust local economic conditions (high employment, rising wages, sound credit scores, etc.) along with comprehensive lending policies also have a dampening effect on any housing market downturn.