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Volatility in Housing Markets (Part 1 of 2) July 20, 2008

Posted by DustinRJay in Calgary real estate, volatility.
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In general, housing prices have a low volatility compared to other asset classes.  This is due to the underlying fundamental value (rents) being a relatively stable cash flow.  This compares against stocks which have larger variance in earnings and therefore larger volatility in price.

A lookback at historical real estate volatility can help to give a forecast probability cloud.  By comparison, the S&P 500 has a VIX index which is representative of S&P 500 volatility over the next 30 day period and is referred to by some as the fear index.

A quarterly calculation of year over year price changes by histogram for Calgary real estate from Q3 1977 to Q1 2008 helps identify the scale of price changes that could occur in one year.  The results are below:

  • P90: -5.6% (90% chance of price growth being greater than -5.6%)
  • P50: +5.9% (50% chance of price growth being greater than +5.9%)
  • P10: +19.9% (10% chance of price growth being greater than +19.9%)

Furthermore, the probability of an event occurring that is above the P10 or below the P90 for 5 consecutive years is 1 in 100,000 for each (i.e.: (1/10)^5 = 1/100,000).  The shortfall of this kind of approach to volatility is that this calculation is not statistically independent as bear and bull markets typically last between 2-10 years.

What this analysis demonstrates is that even if a bearish scenario is the right approach, Mr. Market could take a very long time to unwind.  The following graph illustrates what 5 consecutive P10, P50 and P90 events would look like and is meant to represent the best case, best guess and worst case respectively.