On the op-ed pages of Monday's Wall Street Journal, Chris Mayer, a real estate professor at Columbia University's B-school, and Todd Sinai, a professor at Wharton, explain that the "Chicken Littles" of the real estate market have it all wrong:
"Yet basic economic logic suggests that this apparent evidence of a bubble is anything but. Even in the highest-price cities, housing is, at most, slightly more expensive than average. Here's why: While house prices over the last decade have gone through the roof, the annual cost of owning a house has not."
According to the two B-school professors, "the annual cost of owning, not the price of the house itself, is what homebuyers should (and do) consider when contemplating a purchase."
In other words, forget about skyrocketing housing costs (the traditional method for determining whether a market is overheated or not) and, instead, focus on the annual cost of owning. As calculated by the two B-school professors, the annual cost of owning a house is "the net cash outflow required to own a house for a year - namely, the after-tax cost of financing the purchase price either by borrowing or through the lost risk-adjusted return on the equity tied up in the house, plus carrying costs such as maintenance and economic depreciation - less the expected depreciation on the property."
Now, we're not ones to question the math (although this mathematical definition did cause our heads to spin), especially since the two B-school professors had their results published in the Journal of Economic Perspectives. But, doesn't all this re-defining the terms of the debate sound strangely like the logic used to defend the Internet stock boom?
When Internet companies failed to show any kind of earnings whatsoever, analysts talked about future expected earnings and discounted cash flows. When that logic failed to assuage investor fears, analysts talked up all kinds of funky earnings numbers, like EBITDA (Earnings Before Interest, Taxes, and Depreciation, and Amortization)? Or, as some Wall Street wags liked to joke, "earnings before all the bad stuff"? Remember all those claims about it "being different this time"? Remember how companies came up with all kinds of theories about "first mover advantage" in order to justify multi-million-dollar Super Bowl ad spots?
Thankfully, the New York Post reports that MBA students aren't falling for it anymore:
"In the first poll of its kind, MBAs say they'd rather buy stocks than residential houses because housing prices aren't based on realities the way office buildings are. The booming residential housing market also faces a big tumble, said the survey of more than 1,400 MBA graduates of Dartmouth University's Tuck School of Business. MBAs overwhelmingly said they'd avoid buying houses as a growth investment over the next five years, with 76% giving it a thumbs down. Instead, 94% said they'd prefer to buy stocks for growth over the next five years."